SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 26, 2004
Commission File Number 1-7182
MERRILL LYNCH & CO., INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-2740599
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(State of incorporation) (I.R.S. Employer Identification No.)
4 World Financial Center
New York, New York 10080
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(Address of principal executive offices) (Zip Code)
(212) 449-1000
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Registrant's telephone number, including area code
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES X NO
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
958,115,321 shares of Common Stock and 2,874,972 Exchangeable Shares as of the
close of business on April 27, 2004. The Exchangeable Shares, which were issued
by Merrill Lynch & Co., Canada Ltd. in connection with the merger with Midland
Walwyn Inc., are exchangeable at any time into Common Stock on a one-for-one
basis and entitle holders to dividend, voting, and other rights equivalent to
Common Stock.
MERRILL LYNCH & CO., INC. QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 26, 2004
TABLE OF CONTENTS
Part I. Financial Information 4
Item 1. Financial Statements 4
Condensed Consolidated Statements of Earnings 4
Condensed Consolidated Balance Sheets 5
Condensed Consolidated Statements of Cash Flows 7
Notes to Condensed Consolidated Financial Statements 8
Note 1. Summary of Significant Accounting Policies 8
Note 2. Change in Accounting for Stock-Based Compensation 10
Note 3. Other Significant Events 10
Note 4. Segment Information 10
Note 5. Investment Securities 12
Note 6. Securitization Transactions and Transactions with
Special Purpose Entities (SPEs) 12
Note 7. Loans, Notes, and Mortgages and Related Commitments
to Extend Credit 19
Note 8. Commercial Paper, Short- and Long-Term Borrowings,
and Bank Deposits 20
Note 9. Comprehensive Income 21
Note 10. Earnings Per Share 22
Note 11. Commitments, Contingencies and Guarantees 22
Note 12. Employee Benefit Plans 27
Note 13. Regulatory Requirements 27
Independent Auditors' Report 30
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 31
Forward Looking Statements 31
Business Environment 32
Results of Operations 33
Consolidated Results of Operations 33
Business Segments 35
Consolidated Balance Sheets 41
Off Balance Sheet Arrangements 42
Contractual Obligations 42
Capital Adequacy and Funding 43
Risk Management 45
Non-Investment Grade Holdings and Highly Leveraged Transactions 47
Critical Accounting Policies and Estimates 49
New Accounting Pronouncements 52
Statistical Data 54
Item 3. Quantitative and Qualitative Disclosures About Market Risk 55
Item 4. Controls and Procedures 55
2
MERRILL LYNCH & CO., INC. QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 26, 2004
TABLE OF CONTENTS
(cont.)
Part II. Other Information 56
Item 1. Legal Proceedings 56
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities 57
Item 4. Submission of Matters to a Vote of Security Holders 57
Item 6. Exhibits and Reports on Form 8-K 58
Signatures 60
Index to Exhibits 61
Available Information
ML & Co.'s internet address is www.ml.com. ML & Co. makes available, free of
charge, our proxy statements, annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934. Investors can find this information under "SEC Filings" through the
investor relations section of our website which can be accessed directly at
www.ir.ml.com. These reports are available through our website as soon as
reasonably practicable after ML & Co. electronically files such material with,
or furnishes it to, the Securities and Exchange Commission ("SEC").
Additionally, Merrill Lynch's Corporate Governance Guidelines, Guidelines for
Business Conduct, Code of Ethics for Financial Professionals and charters for
the committees of our Board of Directors have been filed as exhibits to SEC
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and are also available on Merrill Lynch's Investor
Relations website at www.ir.ml.com. The information on Merrill Lynch's websites
is not incorporated by reference into this report. Shareholders may obtain
copies of these materials, free of charge, upon written request to Judith A.
Witterschein, Corporate Secretary, Merrill Lynch & Co., Inc., 222 Broadway, 17th
Floor, New York, NY 10038-2510.
3
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
For the Three Months Ended
--------------------------------
Mar. 26, Mar. 28, Percent
(in millions, except per share amounts) 2004 2003(1) Inc. (Dec.)
---------- --------- ----------
NET REVENUES
Asset management and portfolio service fees $ 1,315 $ 1,127 16.7 %
Commissions 1,361 1,069 27.3
Principal transactions 1,046 1,025 2.0
Investment banking 837 493 69.8
Other 367 213 72.3
---------- ---------
Subtotal 4,926 3,927 25.4
---------- ---------
Interest and dividend revenues 3,061 3,005 1.9
Less interest expense 1,897 2,128 (10.9)
---------- ---------
Net interest profit 1,164 877 32.7
---------- ---------
TOTAL NET REVENUES 6,090 4,804 26.8
---------- ---------
NON-INTEREST EXPENSES
Compensation and benefits 3,047 2,561 19.0
Communications and technology 341 403 (15.4)
Occupancy and related depreciation 217 216 0.5
Brokerage, clearing, and exchange fees 204 170 20.0
Advertising and market development 122 121 0.8
Professional fees 177 144 22.9
Office supplies and postage 51 58 (12.1)
Other 239 222 7.7
---------- ---------
TOTAL NON-INTEREST EXPENSES 4,398 3,895 12.9
---------- ---------
EARNINGS BEFORE INCOME TAXES 1,692 909 86.1
Income tax expense 440 266 65.4
---------- ---------
NET EARNINGS $ 1,252 $ 643 94.7
========== =========
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 1,242 $ 634 95.9
========== =========
EARNINGS PER COMMON SHARE
Basic $ 1.34 $ 0.71
========== =========
Diluted $ 1.22 $ 0.67
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DIVIDEND PAID PER COMMON SHARE $ 0.16 $ 0.16
========== =========
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 930.2 887.6
========== =========
Diluted 1019.7 941.9
========== =========
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(1) Prior period amounts have been restated to reflect the retroactive adoption
of the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, as discussed in Note 2.
See Notes to Condensed Consolidated Financial Statements.
4
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Mar. 26, Dec. 26,
(dollars in millions) 2004 2003(1)
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ASSETS
CASH AND CASH EQUIVALENTS $ 12,530 $ 10,150
CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES
OR DEPOSITED WITH CLEARING ORGANIZATIONS 14,514 15,171
SECURITIES FINANCING TRANSACTIONS
Receivables under resale agreements 76,743 71,756
Receivables under securities borrowed transactions 51,076 45,472
-------- --------
127,819 117,228
------- -------
TRADING ASSETS, AT FAIR VALUE (includes securities pledged as collateral of
$21,070 in 2004 and $23,146 in 2003)
Contractual agreements 37,548 37,196
Corporate debt and preferred stock 25,159 22,459
Equities and convertible debentures 24,870 23,170
Non-U.S. governments and agencies 20,490 15,991
Mortgages, mortgage-backed, and asset-backed 19,857 20,508
U.S. Government and agencies 10,163 10,408
Municipals and money markets 3,653 4,577
-------- --------
141,740 134,309
------- -------
INVESTMENT SECURITIES (includes securities pledged as collateral
of $7,977 in 2004 and $6,608 in 2003) 79,866 74,809
SECURITIES RECEIVED AS COLLATERAL 8,307 9,156
OTHER RECEIVABLES
Customers (net of allowance for doubtful accounts of $54 in 2004 and $60 in 2003) 39,065 36,955
Brokers and dealers 9,894 7,346
Interest and other 11,498 11,144
-------- --------
60,457 55,445
-------- --------
LOANS, NOTES, AND MORTGAGES (net of allowances of $308 in 2004 and $318 in 2003) 49,949 50,993
SEPARATE ACCOUNTS ASSETS 17,200 17,034
EQUIPMENT AND FACILITIES (net of accumulated depreciation and amortization
of $5,022 in 2004 and $5,054 in 2003) 2,598 2,612
GOODWILL 4,922 4,814
OTHER ASSETS 5,095 4,595
-------- --------
TOTAL ASSETS $524,997 $496,316
======== ========
5
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Mar. 26, Dec. 26,
(dollars in millions, except per share amount) 2004 2003(1)
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LIABILITIES
SECURITIES FINANCING TRANSACTIONS
Payables under repurchase agreements $ 99,531 $ 96,138
Payables under securities loaned transactions 20,400 11,081
-------- --------
119,931 107,219
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 4,636 5,000
DEPOSITS 78,126 79,457
TRADING LIABILITIES, AT FAIR VALUE
Contractual agreements 45,628 43,353
U.S. Government and agencies 16,739 15,323
Non-U.S. governments and agencies 14,452 12,066
Equities and convertible debentures 12,126 10,793
Corporate debt, municipals and preferred stock 9,649 7,798
-------- --------
98,594 89,333
-------- --------
Obligation to return securities received as collateral 8,307 9,156
Other payables
Customers 30,773 28,859
Brokers and dealers 12,073 19,109
Interest and other 21,709 22,344
-------- --------
64,555 70,312
-------- --------
LIABILITIES OF INSURANCE SUBSIDIARIES 3,351 3,353
SEPARATE ACCOUNTS LIABILITIES 17,200 17,034
LONG-TERM BORROWINGS 96,908 83,299
LONG-TERM DEBT ISSUED TO TOPRSSM PARTNERSHIPS 3,202 3,203
-------- --------
TOTAL LIABILITIES 494,810 467,366
-------- --------
STOCKHOLDERS' EQUITY
PREFERRED STOCKHOLDERS' EQUITY (42,500 shares issued and outstanding,
liquidation preference $10,000 per share) 425 425
-------- --------
COMMON STOCKHOLDERS' EQUITY
Shares exchangeable into common stock 42 43
Common stock (par value $1.33 1/3 per share; authorized: 3,000,000,000 shares;
issued: 2004 - 1,088,230,010 shares; 2003 - 1,063,205,274 shares) 1,451 1,417
Paid-in capital 11,860 10,676
Accumulated other comprehensive loss (net of tax) (488) (551)
Retained earnings 19,847 18,758
-------- --------
32,712 30,343
Less: Treasury stock, at cost (2004 - 124,426,365 shares; 2003 - 117,294,392 shares) 1,707 1,195
Unamortized employee stock grants 1,243 623
-------- --------
TOTAL COMMON STOCKHOLDERS' EQUITY 29,762 28,525
-------- --------
TOTAL STOCKHOLDERS' EQUITY 30,187 28,950
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $524,997 $496,316
======== ========
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(1) Prior period amounts have been restated to reflect the retroactive adoption
of the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, as discussed in Note 2.
See Notes to Condensed Consolidated Financial Statements
6
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Three Months Ended
------------------------------
Mar. 26, Mar. 28,
(dollars in millions) 2004 2003(1)
- ------------------------------------------------------------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 1,252 $ 643
Noncash items included in earnings:
Depreciation and amortization 125 148
Policyholder reserves 36 40
Stock compensation plan expense 136 233
Deferred taxes 70 417
Undistributed (earnings) loss from equity investments (99) 2
Other (175) 51
Changes in operating assets and liabilities:
Trading assets (7,485) (2,923)
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations 243 (210)
Receivables under resale agreements (4,976) (3,141)
Receivables under securities borrowed transactions (5,604) (2,524)
Customer receivables (2,104) (699)
Brokers and dealers receivables (2,548) -
Trading liabilities 7,133 6,513
Payables under repurchase agreements 3,393 (100)
Payables under securities loaned transactions 9,319 1,002
Customer payables 1,914 (172)
Brokers and dealers payables (7,036) 5,217
Other, net (2,344) (1,459)
-------- --------
Cash provided by (used for) operating activities (8,750) 3,038
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities 6,228 6,200
Sales of available-for-sale securities 5,143 15,277
Purchases of available-for-sale securities (14,375) (15,805)
Maturities of held-to-maturity securities 44 39
Purchases of held-to-maturity securities (82) (203)
Loans, notes, and mortgages 1,054 245
Other investments and other assets (381) (1,387)
Equipment and facilities (111) (173)
-------- --------
Cash provided by (used for) investing activities (2,480) 4,193
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Commercial paper and other short-term borrowings (364) (1,844)
Deposits (1,331) 41
Issuance and resale of long-term borrowings 18,302 5,863
Settlement and repurchases of long-term borrowings (4,809) (7,311)
Derivative financing transactions 2,128 -
Issuance of common stock 326 117
Treasury stock repurchases (502) -
Other common stock transactions 23 (24)
Dividends (163) (152)
-------- --------
Cash provided by (used for) financing activities 13,610 (3,310)
-------- --------
Increase in cash and cash equivalents 2,380 3,921
Cash and cash equivalents, beginning of period 10,150 10,211
-------- --------
Cash and cash equivalents, end of period $ 12,530 $ 14,132
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 105 $ 30
Interest 1,765 2,031
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(1) Prior period amounts have been restated to reflect the retroactive adoption of the fair value recognition provisions
of SFAS No. 123, Accounting for Stock-Based Compensation, as discussed in Note 2.
See Notes to Condensed Consolidated Financial Statements
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7
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 26, 2004
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NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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For a complete discussion of Merrill Lynch's accounting policies, refer to the
Annual Report included as an exhibit to Form 10-K for the year ended December
26, 2003 ("2003 Annual Report").
Basis of Presentation
The Condensed Consolidated Financial Statements include the accounts of Merrill
Lynch & Co., Inc. ("ML & Co.") and subsidiaries (collectively, "Merrill Lynch"),
whose subsidiaries are generally controlled through a majority voting interest
but may be controlled by means of a significant minority ownership, by contract,
lease or otherwise. In certain cases, Merrill Lynch subsidiaries (i.e., Variable
Interest Entities ("VIEs")) may also be consolidated based on a risks and
rewards approach as required by Financial Accounting Standards Board ("FASB")
Revised Interpretation No. ("FIN") 46R. All material intercompany balances have
been eliminated. The interim condensed consolidated financial statements for the
three-month periods are unaudited; however, in the opinion of Merrill Lynch
management, all adjustments (consisting of normal recurring accruals) necessary
for a fair statement of the condensed consolidated financial statements have
been included.
These unaudited Condensed Consolidated Financial Statements should be read in
conjunction with the audited consolidated financial statements included in the
2003 Annual Report. The December 26, 2003 restated unaudited Condensed
Consolidated Balance Sheet was derived from the audited 2003 consolidated
financial statements. The nature of Merrill Lynch's business is such that the
results of any interim period are not necessarily indicative of results for a
full year. In presenting the Condensed Consolidated Financial Statements,
management makes estimates that affect the reported amounts and disclosures in
the financial statements. Estimates, by their nature, are based on judgment and
available information. Therefore, actual results could differ from those
estimates and could have a material impact on the Condensed Consolidated
Financial Statements, and it is possible that such changes could occur in the
near term. Certain reclassifications have been made to prior period financial
statements, where appropriate, to conform to the current period presentation.
New Accounting Pronouncements
On January 12, 2004, the FASB issued a final FASB Staff Position ("FSP") 106-1,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 which addresses the Medicare
Prescription Drug Improvement and Modernization Act of 2003 ("the Act") that
was signed into law on December 8, 2003. FSP 106-1 permits a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of the Act. At
December 26, 2003, Merrill Lynch elected to defer accounting for the effects of
the Act, and as a result any measures of the accumulated postretirement benefit
obligation or net periodic postretirement benefit cost in the financial
statements or accompanying notes do not reflect the effects of the Act on the
plan. Furthermore, at March 26, 2004, specific authoritative guidance on the
accounting for the federal subsidy is pending, and that guidance, when issued,
could require Merrill Lynch to change previously reported information. Merrill
Lynch will assess the impact on the Condensed Consolidated Financial Statements
when the final guidance is issued.
8
On December 23, 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 132 (revised 2003), Employers' Disclosures about Pensions
and Other Postretirement Benefits. The revised SFAS No. 132 retains the
disclosure requirements in the original statement and requires additional
disclosures about pension plan assets, benefit obligations, cash flows, benefit
costs and other relevant information. Merrill Lynch adopted the provisions of
SFAS No. 132 as of December 26, 2003. See Note 12 to the Condensed Consolidated
Financial Statements for these disclosures.
In December of 2003, the American Institute or Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 03-3, Accounting for Certain
Loans or Debt Securities Acquired in a Transfer. SOP 03-3 addresses revenue
recognition and impairment assessments for certain loans and debt securities
that were purchased at a discount that was at least in part due to credit
quality. SOP 03-3 states that where expected cash flows from the loan or debt
security can be reasonably estimated, the difference between the purchase price
and the expected cash flows (i.e., the "accretable yield") should be accreted
into income. In instances where the cash flows or the timing of the cash flows
cannot be reasonably estimated, income on the loan or debt security may not be
accreted. In addition, the SOP prohibits the recognition of a reserve for
impairment on the purchase date. Further, the SOP requires that the allowance
for loan losses be supported through a cash flow analysis, on either an
individual or on a pooled basis, for all loans that fall within the scope of the
guidance. Merrill Lynch will adopt SOP 03-3 as of the beginning of fiscal year
2005 and is currently assessing the potential impact on the Condensed
Consolidated Financial Statements.
On July 7, 2003, the AICPA issued SOP 03-1, Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts. The SOP was effective for financial statements for Merrill
Lynch beginning in 2004. The SOP required the establishment of a liability for
contracts that contain death or other insurance benefits using a specified
reserve methodology that is different from the methodology that Merrill Lynch
used to employ. The adoption of SOP 03-1 resulted in an additional $45 million
of pre-tax expense in the first quarter of 2004.
On January 17, 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
which clarifies when an entity should consolidate another entity known as a VIE,
and on December 24, 2003 the FASB issued a revised standard ("FIN 46R"). A VIE
is an entity in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties, and may include many types of SPEs. FIN 46R requires
that an entity consolidate a VIE if that enterprise has a variable interest that
will absorb a majority of the VIE's expected losses, receive a majority of the
VIE's expected residual returns, or both. FIN 46R does not apply to qualifying
special purpose entities ("QSPEs"), the accounting for which is governed by SFAS
No. 140. As permitted by the transition guidance in FIN 46R, Merrill Lynch
adopted the revised standard on an entity-by-entity basis. At December 26, 2003,
Merrill Lynch applied FIN 46R to all VIEs with which it is involved, with the
exception of those VIEs that issue Merrill Lynch Trust Originated Preferred
Securities ("TOPrSSM"). The adoption of FIN 46R at December 26, 2003 was
reported as a cumulative effect of a change in accounting principle and did not
have a material effect on the Consolidated Financial Statements. As of March 26,
2004, Merrill Lynch applied FIN 46R to those VIEs that issue TOPrSSM. As a
result, these VIEs were deconsolidated. The deconsolidation of TOPrSSM did not
have a material impact on the Condensed Consolidated Financial Statements of
Merrill Lynch and was reported by retroactively restating prior period financial
statements. See Note 6 to the Condensed Consolidated Financial Statements for
additional FIN 46R disclosure.
9
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NOTE 2. CHANGE IN ACCOUNTING FOR STOCK-BASED COMPENSATION
- --------------------------------------------------------------------------------
On December 31, 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123, Accounting for Stock-Based Compensation. Effective for the first quarter of
2004, Merrill Lynch adopted the fair value method of accounting for stock-based
accounting under SFAS No. 123, using the retroactive restatement method
described in SFAS No.148. Under the fair value recognition provisions of SFAS
No. 123, stock-based compensation cost is measured at the grant date based on
the value of the award and is recognized as expense over the vesting period. The
December 26, 2003 Condensed Consolidated Balance Sheet has been restated for the
retroactive adoption of the fair value recognition provisions of SFAS No. 123.
Accordingly, the December 26, 2003 Condensed Consolidated Balance Sheet reflects
a $4.0 billion increase in paid-in capital, a $2.7 billion decrease in retained
earnings, and a $1.3 billion increase in deferred income tax assets. During the
first quarter of 2004 and 2003, $59 million and $65 million, respectively, of
stock option compensation expense was recorded in earnings. See Note 15 to the
2003 Annual Report for additional information related to stock-based
compensation.
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NOTE 3. OTHER SIGNIFICANT EVENTS
- --------------------------------------------------------------------------------
Restructuring and Other Charges
During the fourth quarter of 2001, Merrill Lynch's management formally committed
to a restructuring plan designed to position Merrill Lynch for improved
profitability and growth, which included the resizing of selected businesses and
other structural changes. As a result, Merrill Lynch incurred a 2001 fourth
quarter pre-tax charge to earnings of $2.2 billion, which included restructuring
costs of $1.8 billion and other charges of $396 million. Utilization of the
restructuring reserve at March 26, 2004 is as follows:
(dollars in millions)
- ----------------------------------------------------------------------------------------------
Balance Utilized in Balance
Dec. 26, 2003 2004 March 26,2004
- ----------------------------------------------------------------------------------------------
Category:
Severance costs $ 5 $ (2) $ 3
Facilities costs 206 (15) 191
Other Costs 20 (8)(1) 12
----- ----- ----
$ 231 $ (25) $206
- ---------------------------------------------------------------------------------------------
(1) Represents a change in estimate which was attributable to differences in
actual costs from initial estimates in implementing the original
restructuring plan.
- --------------------------------------------------------------------------------
Note 4. Segment Information
- --------------------------------------------------------------------------------
In reporting to management, Merrill Lynch's operating results are categorized
into three business segments: the Global Markets and Investment Banking Group
("GMI"), Global Private Client ("GPC") and Merrill Lynch Investment Managers
("MLIM"). Prior period amounts have been restated to conform to the current
period presentation. For information on each segment's business activities, see
the 2003 Annual Report.
10
Results by business segment are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
Corporate
GMI GPC MLIM Items Total
-------- ------- ------ --------- --------
Three Months Ended
March 26, 2004
Non-interest revenues $ 2,361 $ 2,161 $ 407 $ (3)(1) $ 4,926
Net interest profit(2) 874 339 5 (54)(3) 1,164
-------- ------- ------ ------ --------
Net revenues 3,235 2,500 412 (57) 6,090
Non-interest expenses 2,120 1,990 301 (13)(1) 4,398
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 1,115 $ 510 $ 111 $ (44) $ 1,692
======== ======= ====== ====== ========
Quarter-end total assets $449,467 $62,771 $7,263 $5,496 $524,997
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
Corporate
GMI GPC MLIM Items Total
-------- ------- ------ --------- --------
Three Months Ended
March 28, 2003
Non-interest revenues $ 1,822 $ 1,779 $ 330 $ (4)(1) $ 3,927
Net interest profit(2) 635 324 7 (89)(3) 877
-------- ------- ------ ------ --------
Net revenues 2,457 2,103 337 (93) 4,804
Non-interest expenses 1,708 1,854 298 35 (1) 3,895
-------- ------- ------ ------ --------
Pre-tax earnings $ 749 $ 249 $ 39 $ (128) $ 909
======== ======= ====== ====== ========
Quarter-end total assets $388,705 $59,157 $4,577 $4,935 $457,374
======== ======= ====== ====== ========
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(1) Primarily represents the elimination of intersegment revenues and expenses.
(2) Management views interest income net of interest expense in evaluating
results.
(3) Represents acquisition financing costs and other corporate interest,
including the impact of TOPrSSM. See Note 6 for additional information on the
impact of TOPrSSM.
11
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NOTE 5. INVESTMENT SECURITIES
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Investment securities at March 26, 2004 and December 26, 2003 are presented
below:
(dollars in millions)
- --------------------------------------------------------------------------------------
Mar. 26, 2004 Dec. 26, 2003
- --------------------------------------------------------------------------------------
Investment securities
Available-for-sale (1) $ 69,366 $ 66,121
Trading 5,676 4,798
Held-to-maturity 706 636
Non-qualifying (2)
Deferred compensation hedges (3) 700 636
Other (4) 9,582 9,197
-------- --------
Total $ 86,030 $ 81,388
- --------------------------------------------------------------------------------------
(1) At March 26, 2004 and December 26, 2003, includes $6.2 billion and $6.6
billion, respectively, of investment securities reported in Cash and
securities segregated for regulatory purposes or deposited with clearing
organizations.
(2) Non-qualifying for SFAS No. 115 purposes.
(3) Represents investments economically hedging deferred compensation
liabilities.
(4) Includes insurance policy loans, merchant banking investments, preferred
stock, TOPrSSM investments, and other non-qualifying investments.
- --------------------------------------------------------------------------------
NOTE 6. SECURITIZATION TRANSACTIONS AND TRANSACTIONS WITH SPECIAL PURPOSE
ENTITIES (SPES)
- --------------------------------------------------------------------------------
In the normal course of business, Merrill Lynch securitizes commercial and
residential mortgage and home equity loans; municipal, government, and corporate
bonds; and other types of financial assets. SPEs are often used when entering
into or facilitating securitization transactions. Merrill Lynch's involvement
with SPEs used to securitize financial assets includes: establishing SPEs;
selling assets to SPEs; structuring SPEs; underwriting, distributing; and making
loans to SPEs; making markets in securities issued by SPEs; engaging in
derivative transactions with SPEs; owning notes or certificates issued by SPEs;
and/or providing liquidity facilities and other guarantees to SPEs.
Merrill Lynch securitized assets of $10.1 billion and $20.5 billion for the
three months ended March 26, 2004 and March 28, 2003, respectively. For the
three months ended March 26, 2004, and March 28, 2003, Merrill Lynch received
$10.2 billion and $20.9 billion, respectively, of proceeds, and other cash
inflows, from new securitization transactions, and recognized net securitization
gains, excluding gains on related derivative transactions, of $33.9 million and
$14.6 million, respectively in Merrill Lynch's Condensed Consolidated Statements
of Earnings. Merrill Lynch generally records assets prior to securitization at
fair value.
12
For the first three months of 2004 and 2003, cash inflows from securitizations
related to the following asset types:
(dollars in millions)
- --------------------------------------------------------------------------------------
Three Months Ended
- --------------------------------------------------------------------------------------
Mar. 26, 2004 Mar. 28, 2003
------------- -------------
Asset category
Residential mortgage loans $ 7,629 $18,313
Municipal bonds 1,734 1,352
Corporate and government bonds 343 223
Commercial loans and other 470 1,010
------- -------
$10,176 $20,898
- --------------------------------------------------------------------------------------
Retained interests in securitized assets were approximately $2.4 billion and
$2.7 billion at March 26, 2004 and December 26, 2003, respectively, which
related primarily to residential mortgage loan and municipal bond securitization
transactions. The majority of the retained interest balance consists of
mortgage-backed securities that have observable market prices. These retained
interests include mortgage-backed securities that Merrill Lynch has purchased
and expects to sell to investors in the normal course of its underwriting
activity. Approximately 65% and 64% at March 26, 2004 and December 26, 2003,
respectively, of residential mortgage loan retained interests consists of
interests in U.S. Government agency sponsored securitizations, which are
guaranteed with respect to principal and interest. In addition, $692 million and
$740 million at March 26, 2004 and December 26, 2003, respectively, of the
retained interest balance relates to municipal bond transactions where
observable market prices are available for the underlying assets, which provide
the inputs and parameters used to calculate the fair value of the retained
interest.
The following table presents information on retained interests, excluding the
offsetting benefit of financial instruments used to hedge risks, held by Merrill
Lynch as of March 26, 2004 arising from Merrill Lynch's residential mortgage
loan, municipal bond and other securitization transactions. The sensitivities of
the current fair value of the retained interests to immediate 10% and 20%
adverse changes in those assumptions and parameters are also shown.
13
(dollars in millions)
- ------------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
- ------------------------------------------------------------------------------------------------------------
Retained interest amount $ 1,684 $ 692 $ 21
Weighted average life (in years) 2.2 3.3 N/A
Range 0.0 - 20.0 0.1 - 6.7 N/A
Weighted average credit losses (rate per annum) 2.4% 0% 2.2%
Range 0.0 - 3.5% 0% 0.0 - 8.0%
Impact on fair value of 10% adverse change $ (4) $ - $ -
Impact on fair value of 20% adverse change $ (10) $ - $ (1)
Weighted average discount rate 6.5% 2.3% 19.2%
Range 0.0 - 147.4% 1.1 - 7.5% 4.5 - 25.0%
Impact on fair value of 10% adverse change $ (7) $ (51) $ (1)
Impact on fair value of 20% adverse change $ (13) $ (96) $ (1)
Weighted average prepayment speed (CPR) 19.5% 15.2%(1) N/A
Range 12.5 - 55.0% 7.0 - 24.0%(1) N/A
Impact on fair value of 10% adverse change $ (14) $ (1) N/A
Impact on fair value of 20% adverse change $ (27) $ (2) N/A
- ------------------------------------------------------------------------------------------------------------
N/A=Not Applicable
CPR=Constant Prepayment Rate
(1) Relates to select securitization transactions where assets are prepayable.
The preceding table does not include the offsetting benefit of financial
instruments that Merrill Lynch utilizes to hedge risks including credit,
interest rate, and prepayment risk that are inherent in the retained interests.
Merrill Lynch employs hedging strategies that are structured to take into
consideration the hypothetical stress scenarios above such that they would be
effective in principally offsetting Merrill Lynch's exposure to loss in the
event these scenarios occur. In addition, the sensitivity analysis is
hypothetical and should be used with caution. In particular, the effect of a
variation in a particular assumption on the fair value of the retained interest
is calculated independent of changes in any other assumption; in practice,
changes in one factor may result in changes in another, which might magnify or
counteract the sensitivities. Further, changes in fair value based on a 10% or
20% variation in an assumption or parameter generally cannot be extrapolated
because the relationship of the change in the assumption to the change in fair
value may not be linear. Also, the sensitivity analysis does not consider any
hedging activity that Merrill Lynch may take to mitigate the impact of any
adverse changes in the key assumptions.
The weighted average assumptions and parameters used initially to value retained
interests relating to securitizations effected in 2004 that were still held by
Merrill Lynch as of March 26, 2004 are as follows:
- ------------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
- ------------------------------------------------------------------------------------------------------------
Weighted average life (in years) 4.0 N/A N/A
Credit losses (rate per annum) 0.2% 0% 0.8%
Weighted average discount rate 4.3% 3.1% 13.3%
Prepayment speed assumption (CPR) 17.9% N/A N/A
- ------------------------------------------------------------------------------------------------------------
N/A=Not Applicable
CPR=Constant Prepayment Rate
14
For residential mortgage loan and other securitizations, the investors and the
securitization trust have no recourse to Merrill Lynch's other assets for
failure of mortgage holders to pay when due.
For municipal bond securitization SPEs, in the normal course of dealer
market-making activities, Merrill Lynch acts as liquidity provider.
Specifically, the holders of beneficial interests issued by municipal bond
securitization SPEs have the right to tender their interests for purchase by
Merrill Lynch on specified dates at a specified price. Beneficial interests that
are tendered are then sold by Merrill Lynch to investors through a best efforts
remarketing where Merrill Lynch is the remarketing agent. If the beneficial
interests are not successfully remarketed, the holders of beneficial interests
are paid from funds drawn under a standby liquidity letter of credit issued by
Merrill Lynch.
Merrill Lynch also provides default protection or credit enhancement to
investors in securities issued by certain municipal bond securitization SPEs.
Interest and principal payments on beneficial interests issued by these SPEs are
secured by a guarantee issued by Merrill Lynch. In the event that the issuer of
the underlying municipal bond defaults on any payment of principal and/or
interest when due, the payments on the bonds will be made to beneficial interest
holders from an irrevocable guarantee by Merrill Lynch.
The maximum commitment under these liquidity and default guarantees totaled
$17.2 billion and $17.0 billion at March 26, 2004 and December 26, 2003,
respectively. The fair value of the commitments approximated $202 million and
$126 million at March 26, 2004 and December 26, 2003, respectively, which is
reflected in the Condensed Consolidated Financial Statements. Of these
arrangements, $2.7 billion and $2.8 billion at March 26, 2004 and December 26,
2003, respectively, represent agreements where the guarantee is provided to the
SPE by a third party financial intermediary and Merrill Lynch enters into a
reimbursement agreement with the financial intermediary. In these arrangements,
if the financial intermediary incurs losses, Merrill Lynch has up to one year to
fund those losses. Additional information regarding these commitments is
provided in Note 11 to the Condensed Consolidated Financial Statements and in
Note 13 in the 2003 Annual Report.
The following table summarizes principal amounts outstanding, delinquencies, and
net credit losses of securitized financial assets as of March 26, 2004 and
December 26, 2003.
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
-------------- --------- ------
March 26, 2004
Principal Amount Outstanding $50,455 $13,705 $2,931
Delinquencies 44 - -
Net Credit Losses - - 1
- -----------------------------------------------------------------------------------------------------------
December 26, 2003
Principal Amount Outstanding $43,777 $14,890 $4,527
Delinquencies 54 - -
Net Credit Losses 3 - 8
- -----------------------------------------------------------------------------------------------------------
15
Variable Interest Entities
In January 2003, the FASB issued FIN 46, which clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements, for
enterprises that have interests in entities that meet the definition of a VIE,
and on December 24, 2003, the FASB issued FIN 46R. A VIE is an entity in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN 46R requires that an entity shall consolidate a VIE if that enterprise has a
variable interest that will absorb a majority of the VIE's expected losses;
receive a majority of the VIE's expected residual returns; or both.
As permitted under the transition guidance, Merrill Lynch adopted the provisions
of FIN 46R on an entity-by-entity basis. At December 26, 2003 Merrill Lynch
applied FIN 46R for purposes of determining those VIEs that must be consolidated
or disclosed as giving rise to a significant variable interest, with the
exception of those VIEs that issue TOPrSSM, in which case Merrill Lynch applied
FIN 46R beginning in the first quarter of 2004. Merrill Lynch accounted for
those VIEs that were consolidated under FIN 46R at year-end 2003 as a cumulative
effect of a change in accounting principle, which did not have a material effect
on the year-end 2003 consolidated financial statements.
During the first quarter of 2004, in accordance with FIN 46R, Merrill Lynch
deconsolidated the partnerships and trusts that issue TOPrSSM since Merrill
Lynch does not bear the majority of the risks and rewards of those entities. As
a result, the dividends, of approximately $48 million per quarter, related to
the TOPrSSM have been reclassified from dividends on preferred securities issued
by subsidiaries to net revenues (primarily interest expense), and the debt, of
approximately $3.2 billion, and partnership interests, of $574 million, related
to the entities have been included in the Condensed Consolidated Balance Sheets
as Long-term debt issued to TOPrSSM partnerships and Investment securities,
respectively. Merrill Lynch has reflected the deconsolidation of TOPrSSM by
retroactively restating prior period financial statements in order to provide
comparability from period to period.
Merrill Lynch has entered into transactions with a number of VIEs in which it is
the primary beneficiary and therefore must consolidate the VIE; or is a
significant variable interest holder in the VIE. These VIEs are as follows:
o Merrill Lynch is the primary beneficiary of VIEs that own convertible bonds
purchased from Merrill Lynch, in which Merrill Lynch maintains a call option to
repurchase the convertible bonds from the VIE. The purpose of these VIEs is to
market convertible bonds to a broad investor base by separating the bonds into
callable debt and a conversion call option. Assets held by these VIEs are
reported in Equities and convertible debentures or resale agreements, depending
on the nature of the transaction, in the Condensed Consolidated Balance Sheet.
Holders of the beneficial interests in these VIEs have no recourse to the
general credit of Merrill Lynch; their investment is paid exclusively from the
convertible bonds held by the VIE.
o Merrill Lynch is the primary beneficiary of "maturity shortening
transactions," in which the VIE serves to shorten the maturity of a fixed income
security, and, at the maturity date of the VIE, Merrill Lynch has the obligation
to repurchase some or all of the securities held by the VIE. Assets held by
these VIEs are reported in Corporate debt and preferred stock. The beneficial
interest holders in these VIEs have recourse to Merrill Lynch to the extent that
the underlying assets that Merrill Lynch is required to repurchase have declined
in value from the initial transaction date.
o Merrill Lynch is the sponsor and guarantor of VIEs that provide a guarantee of
principal to beneficial interest holders, thereby limiting investors' losses
generated from the assets. Merrill Lynch may also guarantee investors' returns
in excess of principal depending on the nature of the fund. In certain of these
VIEs, Merrill Lynch is the primary beneficiary. Investors in these VIEs have
recourse to Merrill Lynch to the extent that the value of the assets held by the
VIEs at maturity is less than the investors' initial investment or guaranteed
amount. Where Merrill Lynch is not the primary beneficiary, guarantees related
to these funds are discussed and disclosed in Note 11 to the Condensed
Consolidated Financial Statements.
16
o Merrill Lynch has made loans to, and/or investments in, VIEs that hold loan
receivable assets and real estate, and as a result of these loans and
investments, Merrill Lynch may be either the primary beneficiary of and
consolidate the VIE, or may be a significant variable interest holder. These
VIEs are primarily designed to provide temporary on or off-balance sheet
financing to clients and/or to invest in real estate. Assets held by VIEs where
ML has provided financing and is the primary beneficiary are recorded in Other
assets and/or Loans, notes and mortgages in the Condensed Consolidated Balance
Sheet. Assets held by VIEs where Merrill Lynch has invested in real estate
partnerships are classified as Investment securities where Merrill Lynch holds a
significant variable interest, and in Other assets where Merrill Lynch is the
primary beneficiary. The beneficial interest holders in these VIEs have no
recourse to the general credit of Merrill Lynch; their investments are paid
exclusively from the assets in the VIE.
o Merrill Lynch has a significant variable interest in municipal bond
securitization QSPEs to which it provides liquidity and default facilities.
Additional information on these programs is provided in the retained interest
securitization disclosures above and in Note 11 to the Condensed Consolidated
Financial Statements.
o Merrill Lynch has entered into transactions with VIEs that are used, in part,
to provide foreign tax planning strategies to investors. Merrill Lynch is a
significant variable interest holder in these VIEs.
o Merrill Lynch has a significant variable interest in a residential mortgage
securitization entered into by one of its banking subsidiaries. Specifically,
ML retains a 97% interest in the VIE. In accordance with the previous accounting
guidance of SFAS No. 125, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, this entity qualifies as a QSPE and
therefore Merrill Lynch does not consolidate the VIE. The 97% interest is
reported in Investment securities on Merrill Lynch's Condensed Consolidated
Balance Sheets.
o Merrill Lynch has entered into transactions with VIEs where Merrill Lynch is a
derivative counterparty to a VIE that serves to synthetically expose investors
to a specific credit risk. Based on the provisions of FIN 46R, Merrill Lynch
does not have a significant variable interest since the derivative it has
purchased does not absorb variability of the VIE. However, because these
structures represent a significant Merrill Lynch sponsored program, information
related to these structures has been included in the following table.
The following tables summarize Merrill Lynch's involvement with the VIEs listed
above as of March 26, 2004 and December 26, 2003, respectively. Where an entity
is a significant variable interest holder, FIN 46R requires that entity to
disclose its maximum exposure to loss as a result of its interest in the VIE. It
should be noted that this measure does not reflect Merrill Lynch's estimate of
the actual losses that could result from adverse changes because it does not
reflect the economic hedges Merrill Lynch enters into to reduce its exposure.
17
(dollars in millions)
- ---------------------------------------- ----------------------------------------------------------------------------
March 26, 2004
Primary Beneficiary Significant Variable Interest Holder
- ---------------------------------------------------------------------------------------------------------------------
Asset Recourse to Merrill Asset Maximum
Description Size Lynch(4) Size Exposure
- ---------------------------------------------------------------------------------------------------------------------
Convertible Bond Stripping $1,315 None $ - $ -
Maturity Shortening 369 $ 1 - -
Guaranteed Funds 941 941 - -
Loan and Real Estate VIEs 753 None 795 692
Municipal Bond Securitizations(1) - - 17,154 17,154
Foreign Tax Planning VIEs(2) - - 2,811 129
Mortgage Securitization - - 329 319
Synthetic Credit Risk VIEs(3) - - 6,986 572
- ---------------------------------------------------------------------------------------------------------------------
(dollars in millions)
- ---------------------------------------------------------------------------------------------------------------------
December 26, 2003
Primary Beneficiary Significant Variable Interest Holder
- ---------------------------------------------------------------------------------------------------------------------
Asset Recourse to Merrill Asset Maximum
Description Size Lynch(4) Size Exposure
- ---------------------------------------------------------------------------------------------------------------------
Convertible Bond Stripping $1,864 None $ - $ -
Maturity Shortening 379 $1 - -
Guaranteed Funds 863 863 - -
Loan and Real Estate VIEs 775 None 636 567
Municipal Bond Securitizations(1) - - 16,927 16,927
Foreign Tax Planning VIEs(2) - - 2,811 114
Mortgage Securitization - - 345 334
Synthetic Credit Risk VIEs(3) - - 6,402 474
- ---------------------------------------------------------------------------------------------------------------------
(1)The maximum exposure for Municipal Bond Securitizations reflects
Merrill Lynch's potential liability as a result of the liquidity and
default facilities entered into with the VIEs. It significantly
overestimates Merrill Lynch's probability weighted exposure to these
VIEs because it does not reflect the economic hedges that are designed to be
effective in principally offsetting Merrill Lynch's exposure to loss.
(2)The maximum exposure for Foreign Tax Planning VIEs reflects the fair
value of derivatives entered into with the VIEs, as well as the maximum
exposure to loss associated with indemnifications made to investors in
the VIEs.
(3)The maximum exposure for Synthetic Credit Risk VIEs is the asset
carrying value of the derivatives entered into with the VIEs as of
March 26, 2004 and December 26, 2003, respectively.
(4)This column reflects the extent, if any, to which investors have
recourse to Merrill Lynch beyond the assets held in the VIE.
18
- --------------------------------------------------------------------------------
NOTE 7. LOANS, NOTES, AND MORTGAGES AND RELATED COMMITMENTS TO EXTEND CREDIT
- --------------------------------------------------------------------------------
Loans, Notes, and Mortgages and related commitments to extend credit at March
26, 2004 and December 26, 2003, are presented below:
(dollars in millions)
- ---------------------------------------------------------------------------------------------------------------------
Loans Commitments
- ---------------------------------------------------------------------------------------------------------------------
Mar. 26, 2004 Dec. 26, 2003 Mar. 26, 2004(1) Dec. 26, 2003
- ---------------------------------------------------------------------------------------------------------------------
Consumer and small- and middle-market business:
Mortgages $16,734 $16,688 $ 5,208 $ 4,842
Small- and middle-market business 6,954 6,737 3,408 3,411
Other 3,035 4,045 665 603
Commercial:
Secured 21,275 21,048 15,461 12,425
Unsecured investment grade 1,268 1,806 17,967 15,028
Unsecured non-investment grade 683 669 874 562
------- ------- ------- -------
Total $49,949 $50,993 $43,583 $36,871
- ---------------------------------------------------------------------------------------------------------------------
(1) See Note 11 for the maturity profile of these commitments.
The loan amounts are net of an allowance for loan losses of $308 million and
$318 million as of March 26, 2004 and December 26, 2003, respectively.
Consumer and small- and middle-market business loans, substantially all of which
are secured by real and/or personal property, consisted of approximately 203,100
individual loans at March 26, 2004 and included residential mortgages, home
equity loans, small- and middle-market business loans, and other loans to
individuals for household, family, or other personal expenditures. Commercial
loans, which at March 26, 2004 consisted of approximately 6,900 separate loans,
included syndicated loans and other loans to corporations and other businesses.
Secured loans and commitments include lending activities made in the normal
course of Merrill Lynch's securities and financing businesses. The investment
grade and non-investment grade categorization is determined using the credit
rating agency equivalent of internal credit ratings. Non-investment grade
counterparties are those rated lower than BBB. Merrill Lynch enters into credit
default swaps to mitigate credit exposure primarily related to funded and
unfunded unsecured commercial loans. The notional value of these swaps totaled
$4.9 billion at March 26, 2004 and December 26, 2003.
The above amounts include $8.3 billion and $7.6 billion of loans held for sale
at March 26, 2004 and December 26, 2003, respectively. Loans held for sale are
loans which management expects to sell prior to maturity. At March 26, 2004,
such loans consisted of $4.8 billion of consumer loans, primarily residential
mortgages, and $3.5 billion of commercial loans, approximately 65% of which are
to investment grade counterparties. At December 26, 2003, such loans consisted
of $5.2 billion of consumer loans, primarily residential mortgages, and $2.4
billion of commercial loans, approximately 59% of which were to investment grade
counterparties. For information on the accounting policy related to loans,
notes, and mortgages, see Note 1 in the 2003 Annual Report.
19
- --------------------------------------------------------------------------------
NOTE 8. COMMERCIAL PAPER, SHORT- AND LONG-TERM BORROWINGS, AND BANK DEPOSITS
- --------------------------------------------------------------------------------
Commercial paper and Other short-term borrowings and Bank deposits at March 26,
2004 and December 26, 2003 are presented below:
(dollars in millions)
- --------------------------------------------------------------------------------------
Mar. 26, 2004 Dec. 26, 2003
- --------------------------------------------------------------------------------------
Commercial paper and other short-term
borrowings
Commercial paper $ 3,822 $ 4,568
Other 814 432
------- -------
Total $ 4,636 $ 5,000
------- -------
Bank deposits
U.S. $65,441 $65,409
Non U.S. 12,685 14,048
------- -------
Total $78,126 $79,457
- --------------------------------------------------------------------------------------
Long-term borrowings
Merrill Lynch issues debt and Certificates of deposit whose coupons or repayment
terms are linked to the performance of equity or other indices (e.g., S&P 500)
or baskets of securities. These instruments are assessed to determine if there
is an embedded derivative that requires separate reporting and accounting.
Beginning in 2004, in accordance with SEC guidance, Merrill Lynch amortizes any
upfront profit associated with the embedded derivative into income as a
yield adjustment over the life of the related debt instrument or Certificate of
deposit.
In March 2002, Merrill Lynch issued $2.3 billion aggregate original principal
amount of floating rate zero-coupon contingently convertible debt (Liquid Yield
OptionTM notes or LYONs(R)) at an issue price of $1,000 per note. At maturity,
the LYONs(R) holder will receive the original principal amount of $1,000
increased daily by a variable rate. The LYONs(R) are unsecured and
unsubordinated indebtedness of Merrill Lynch with a maturity date of 30 years.
Merrill Lynch will pay no interest prior to maturity unless, during any
six-month period beginning June 1, 2007, the average market price of a LYONs(R)
for a certain period exceeds 120% of the accreted value of the LYONs(R). Holders
of LYONs(R) may convert each security into 13.8213 shares (i.e., the "conversion
rate") of Merrill Lynch common stock based on the conditions described below.
In May 2001, Merrill Lynch issued $4.6 billion of aggregate original principal
amount of fixed rate contingently convertible LYONs(R) at an issue price of
$511.08 per note, which resulted in gross proceeds of approximately $2.4
billion. Each note has a yield to maturity of 2.25% with a maturity value of
$1,000 on May 23, 2031. Merrill Lynch is amortizing the issue discount using the
effective interest method over the term of the LYONs(R). The LYONs(R) are
unsecured unsubordinated indebtedness of Merrill Lynch with a maturity of 30
years. Merrill Lynch will pay no interest prior to maturity unless, during any
six-month period beginning June 1, 2006, the average market price of a LYONs(R)
for a certain period exceeds 120% of the accreted value of the LYONs(R). Holders
of LYONs(R) may convert each security into 5.6787 shares (i.e., the "conversion
rate") of common stock based on the conditions described below.
20
The conversion rate for both of Merrill Lynch's LYONs(R) will be adjusted for:
o Dividends or distributions payable in Merrill Lynch common stock.
o Distributions to all holders of Merrill Lynch common stock of certain
rights to purchase the stock at less than the sale price of Merrill
Lynch stock at that time.
o Distribution of Merrill Lynch assets to holders of Merrill Lynch common
stock (excluding cash dividends that are not extraordinary dividends),
or
o Certain corporate events, such as consolidation, merger or transfer of
all, or substantially all, of Merrill Lynch's assets.
Both of Merrill Lynch LYONs(R) issuances may be converted based on any of the
following conditions:
o If the closing price of Merrill Lynch common stock for at least 20 of
the last 30 consecutive trading days ending on the last day of the
quarter is more than the conversion trigger price. The conversion
trigger price for the floating rate LYONs(R) at March 26, 2004 was
$86.82. (That is, at March 26, 2004, a holder could have converted a
floating rate LYONs(R) into 13.8213 shares of Merrill Lynch stock if
the Merrill Lynch stock price had been greater than $86.82 for at least
20 of the last 30 consecutive trading days at the end of the last day
of the quarter). The conversion trigger price for the fixed rate
LYONs(R) at March 26, 2004 was $113.76. The conversion trigger price
will change each quarter based on the accreted value of the LYONs(R)
at that date.
o During any period in which the credit rating of LYONs(R) is Baa1 or
lower by Moody's Investor Services, Inc., BBB+ or lower by Standard &
Poor's Credit Market Services, or BBB+ or lower by Fitch, Inc.
o If the LYONs(R)are called for redemption.
o If Merrill Lynch is party to a consolidation, merger or binding share
exchange, or
o If Merrill Lynch makes a distribution that has a per share value equal
to more than 15% of the sale price of its shares on the day preceding
the declaration date for such distribution.
As of March 26, 2004 none of the conversion triggers above had been met and, as
a result, the related shares have not been included in the diluted EPS
calculation.
Holders of LYONs(R) may require Merrill Lynch to repurchase their convertible
instruments at accreted value on various dates prior to maturity. The initial
put date for holders of floating rate LYONs(R) is March 13, 2005. The initial
put date for fixed rate LYONs(R) is May 23, 2004. Merrill Lynch may pay the
purchase price in cash, shares or any combination thereof. Merrill Lynch has
elected to pay the purchase price for any fixed rate LYONs(R) that are put back
to Merrill Lynch on May 23, 2004, with cash. The maximum cash payment assuming
the entire issue is put back to Merrill Lynch, would be $2.5 billion.
For further information regarding Merrill Lynch LYONs(R) issuances, refer to
Note 9 of the 2003 Annual Report.
- --------------------------------------------------------------------------------
NOTE 9. COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
The components of comprehensive income are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------
Three Months Ended
------------------------
Mar. 26, Mar. 28,
2004 2003
------ -------
Net Earnings $1,252 $643
------ -------
Other comprehensive income, net of tax:
Currency translation adjustment (8) 6
Net unrealized gain on investment
securities available-for-sale 63 18
Deferred gain on cash flow hedges 8 6
------ ------
Total other comprehensive income, net of tax 63 30
------ ------
Comprehensive income $1,315 $673
- --------------------------------------------------------------------------------------------
21
- --------------------------------------------------------------------------------
NOTE 10. EARNINGS PER SHARE
- --------------------------------------------------------------------------------
The computation of earnings per common share is as follows:
(dollars in millions, except per share amounts)
- ---------------------------------------------------------------------------------------------------
Three Months Ended
-------------------------
Mar. 26, Mar.28,
2004 2003
-------- --------
Net Earnings $ 1,252 $ 643
Preferred stock dividends 10 9
-------- --------
Net earnings applicable to common stockholders $ 1,242 $ 634
-------- --------
- ---------------------------------------------------------------------------------------------------
(shares in thousands)
Weighted-average shares outstanding 930,155 887,553
-------- --------
Effect of dilutive instruments(1) (2):
Employee stock options 46,214 21,108
Financial Advisor Capital Accumulation Award Plan shares 23,353 20,373
Restricted shares and units 19,929 12,723
Employee Stock Purchase Plan shares - 118
-------- --------
Dilutive potential common shares 89,496 54,322
-------- --------
Total weighted-average diluted shares 1,019,651 941,875
-------- --------
- ---------------------------------------------------------------------------------------------------
Basic earnings per common share $ 1.34 $ 0.71
Diluted earnings per common share $ 1.22 $ 0.67
- ---------------------------------------------------------------------------------------------------
(1)During the 2004 and 2003 first quarter there were 40 million and 159
million instruments, respectively, that were considered antidilutive and
thus were not included in the above calculations. Additionally, shares
related to Merrill Lynch's LYONs(R) issuance are not included in the
computation of diluted earnings per share because the threshold trigger
price for conversion has not been reached. See Note 8 to the Condensed
Consolidated Financial Statements.
(2)See Note 15 to the 2003 Annual Report for a description of these instruments.
- --------------------------------------------------------------------------------
NOTE 11. COMMITMENTS, CONTINGENCIES AND GUARANTEES
- --------------------------------------------------------------------------------
Litigation
Merrill Lynch has been named as a defendant in various legal actions, including
arbitrations, class actions, and other litigation arising in connection with its
activities as a global diversified financial services institution. The general
decline of equity securities prices between 2000 and 2003 has resulted in
increased legal actions against many firms, including Merrill Lynch, and will
likely result in higher professional fees and litigation expenses than those
incurred in the past.
Some of the legal actions include claims for substantial compensatory and/or
punitive damages or claims for indeterminate amounts of damages. In some cases,
the issuers who would otherwise be the primary defendants in such cases are
bankrupt or otherwise in financial distress. Merrill Lynch is also involved in
investigations and/or proceedings by governmental and self-regulatory agencies.
The number of these investigations has also increased in recent years with
regard to many firms, including Merrill Lynch.
22
Given the number of these legal actions, investigations and proceedings, some
are likely to result in adverse judgments, settlements, penalties, injunctions,
fines, or other relief. Merrill Lynch believes it has strong defenses to, and
where appropriate, will vigorously contest these actions. In many cases,
including the class action lawsuits disclosed in Item 3 of the 2003 Form 10-K,
it is not possible to determine whether a liability has been incurred or to
estimate the ultimate or minimum amount of that liability until years after the
litigation has been commenced, in which case no accrual is made until that time.
In view of the inherent difficulty of predicting the outcome of such matters,
particularly in cases in which claimants seek substantial or indeterminate
damages, Merrill Lynch often cannot predict what the eventual loss or range of
loss related to such matters will be. Merrill Lynch believes, based on
information available to it, that the resolution of these actions will not have
a material adverse effect on the financial condition of Merrill Lynch as set
forth in the Condensed Consolidated Financial Statements, but may be material to
Merrill Lynch's operating results or cash flows for any particular period and
may impact ML & Co.'s credit ratings.
Commitments
At March 26, 2004, Merrill Lynch's commitments had the following expirations:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------------
Commitment expiration
-----------------------------------------------------
Less than 1 Over 5
Total year 1- 3 years 3+ - 5 years years
- ----------------------------------------------------------------------------------------------------------------
Commitments to extend credit(1) $43,583 $19,887 $10,107 $7,824 $5,765
Purchasing and other commitments 8,663 7,408 570 449 236
Operating leases 3,809 525 1,010 845 1,429
Resale agreements 14,821 14,821 - - -
------- ------- ------- ------ ------
Total $70,876 $42,641 $11,687 $9,118 $7,430
- ----------------------------------------------------------------------------------------------------------------
(1) See Note 7 to the Condensed Consolidated Financial Statements and Note 13 in
the 2003 Annual Report for additional details.
Other Commitments
Merrill Lynch also obtains commercial letters of credit from issuing banks to
satisfy various counterparty collateral requirements in lieu of depositing cash
or securities collateral. Commercial letters of credit aggregated $565 million
and $507 million at March 26, 2004 and December 26, 2003, respectively.
Merrill Lynch has commitments to purchase partnership interests, primarily
related to private equity investing activities, of $406 million and $426 million
at March 26, 2004 and December 26, 2003, respectively. Merrill Lynch also has
entered into agreements with providers of market data, communications, and
systems consulting services. At March 26, 2004 and December 26, 2003 minimum fee
commitments over the remaining life of these agreements aggregated $492 million
and $503 million, respectively. Merrill Lynch has entered into other purchasing
commitments totaling $7.8 billion and $7.4 billion at March 26, 2004 and
December 26, 2003, respectively.
23
Leases
Merrill Lynch has entered into various noncancellable long-term lease agreements
for premises that expire through 2024. Merrill Lynch has also entered into
various noncancellable short-term lease agreements, which are primarily
commitments of less than one year under equipment leases.
In 1999 and 2000, Merrill Lynch established two SPEs to finance its Hopewell,
New Jersey campus and an aircraft. Merrill Lynch leased the facilities and the
aircraft from the SPEs. The total amount of funds raised by the SPEs to finance
these transactions was $383 million. These SPEs were not consolidated by Merrill
Lynch pursuant to accounting guidance. In the second quarter of 2003, the
facilities and aircraft owned by these SPEs were acquired by a newly created
limited partnership, which is unaffiliated with Merrill Lynch. The limited
partnership acquired the assets subject to the leases with Merrill Lynch as well
as the existing indebtedness incurred by the original SPEs. The proceeds from
the sale of the assets to the limited partnership, net of the debt assumed by
the limited partnership, were used to repay the equity investors in the original
SPEs. After the transaction was completed, the original SPEs were dissolved. The
limited partnership has also entered into leases with third parties unrelated to
Merrill Lynch.
The leases with the limited partnership mature in 2005 and 2006, and each lease
has a renewal term to 2008. In addition, Merrill Lynch has entered into
guarantees with the limited partnership, whereby if Merrill Lynch does not renew
the lease or purchase the assets under its lease at the end of either the
initial or the renewal lease term, the underlying assets will be sold to a third
party, and Merrill Lynch has guaranteed that the proceeds of such sale will
amount to at least 84% of the acquisition cost of the assets. The maximum
exposure to Merrill Lynch as a result of this residual value guarantee is
approximately $325 million as of March 26, 2004. As of March 26, 2004, the
carrying value of the liability on the Condensed Consolidated Financial
Statements is $32 million. Merrill Lynch's residual value guarantee does not
comprise more than half of the limited partnership's assets.
The limited partnership does not meet the definition of a variable interest
entity as defined in FIN 46R and Merrill Lynch does not have a partnership or
other interest in the limited partnership. Accordingly, Merrill Lynch is not
required to consolidate the limited partnership in its financial statements. The
leases with the limited partnership are accounted for as operating leases.
Guarantees
Merrill Lynch issues various guarantees to counterparties in connection with
certain leasing, securitization and other transactions. In addition, Merrill
Lynch enters into certain derivative contracts that meet the accounting
definition of a guarantee under FIN 45. FIN 45 defines guarantees to include
derivative contracts that contingently require a guarantor to make payment to a
guaranteed party based on changes in an underlying (such as changes in the value
of interest rates, security prices, currency rates, commodity prices, indices,
etc.) that relate to an asset, liability or equity security of a guaranteed
party. Derivatives that meet the FIN 45 definition of guarantees include certain
written options and credit default swaps (contracts that require Merrill Lynch
to pay the counterparty the par value of a referenced security if that
referenced security defaults). Merrill Lynch does not track, for accounting
purposes, whether its clients enter into these derivative contracts for
speculative or hedging purposes. Accordingly, Merrill Lynch has disclosed
information about all credit default swaps and certain types of written options
that can potentially be used by clients to protect against changes in an
underlying, regardless of how the contracts are used by the client.
For certain derivative contracts such as written interest rate caps and written
currency options, the maximum payout is not quantifiable, because, for example,
the rise in interest rates or changes in foreign exchange rates could
theoretically be unlimited. In addition, Merrill Lynch does not monitor its
exposure to derivatives in this manner. As such, rather than including the
maximum payout, the notional value of these contracts has been included to
provide information about the magnitude of involvement with these types of
contracts. However, it should be noted that the notional value overstates
Merrill Lynch's exposure to these contracts.
24
Merrill Lynch records all derivative transactions at fair value on its Condensed
Consolidated Balance Sheets. A risk framework is used to define risk tolerances
and establish limits to ensure that certain risk-related losses occur within
acceptable, predefined limits. Merrill Lynch economically hedges its exposure to
these contracts by entering into a variety of offsetting derivative contracts
and security positions. See the Derivatives section of Note 1 in the 2003 Annual
Report for further discussion of risk management of derivatives.
Merrill Lynch also provides guarantees to SPEs in the form of liquidity
facilities, credit default protection and residual value guarantees for
equipment leasing entities.
The liquidity facilities and credit default protection relate primarily to
municipal bond securitization SPEs. Merrill Lynch acts as liquidity provider to
municipal bond securitization SPEs. Specifically, the holders of beneficial
interests issued by these SPEs have the right to tender their interests for
purchase by Merrill Lynch on specified dates at a specified price. If the
beneficial interests are not successfully remarketed, the holders of beneficial
interests are paid from funds drawn under a standby facility issued by Merrill
Lynch (or by third party financial institutions where Merrill Lynch has agreed
to reimburse the financial institution if a draw occurs). If the standby
facility is drawn, Merrill Lynch may claim the underlying assets held by the
SPEs. In general, standby facilities that are not coupled with default
protection are not exercisable in the event of a downgrade below investment
grade or default of the assets held by the SPEs. In addition, the value of the
assets held by the SPE plus any additional collateral pledged to Merrill Lynch
exceeds the amount of beneficial interests issued, which provides additional
support to Merrill Lynch in the event that the standby facility is drawn. The
assets to which Merrill Lynch has recourse are on a deal-by-deal basis and are
not part of a cross collateralized pool. As of March 26, 2004, the value of the
municipal bond assets to which Merrill Lynch has recourse in the event of a draw
was $18.0 billion and the maximum payout if the standby facilities are drawn was
$14.0 billion.
In certain instances, Merrill Lynch also provides default protection in addition
to liquidity facilities. Specifically, in the event that an issuer of a
municipal bond held by the SPE defaults on any payment of principal and/or
interest when due, the payments on the bonds will be made to beneficial interest
holders from an irrevocable guarantee by Merrill Lynch (or by third party
financial institutions where Merrill Lynch has agreed to reimburse the financial
institution if losses occur). If the default protection is drawn, Merrill Lynch
may claim the underlying assets held by the SPEs. As of March 26, 2004, the
value of the assets to which Merrill Lynch has recourse in the event that an
issuer of a municipal bond held by the SPE defaults on any payment of principal
and/or interest when due, was $4.1 billion; the maximum payout if an issuer
defaults was $3.2 billion. As described in the preceding paragraph, the assets
to which Merrill Lynch has recourse are not part of a cross collateralized pool.
Further, to protect against declines in the value of the assets held by SPEs for
which Merrill Lynch provides either liquidity facilities or default protection,
Merrill Lynch economically hedges its exposure though derivative positions that
principally offset the risk of loss arising from these guarantees.
Merrill Lynch also provides residual value guarantees to leasing SPEs where
either Merrill Lynch or a third party is the lessee. For transactions where
Merrill Lynch is not the lessee, the guarantee provides loss coverage for any
shortfalls in the proceeds from asset sales greater than 75 - 90% of the
adjusted acquisition price, as defined. As of March 26, 2004, the value of the
assets for which Merrill Lynch provides residual value guarantees and is not the
lessee was $538 million. Where Merrill Lynch is the lessee, it provides a
guarantee that any proceeds from the sale of the assets will amount to at least
84% of the adjusted acquisition price, as defined.
25
Merrill Lynch also enters into reimbursement agreements in conjunction with
sales of loans originated under its Mortgage 100SM program. Under this program,
borrowers can pledge marketable securities in lieu of making a cash down
payment. Upon sale of these mortgage loans, purchasers may require a surety bond
that reimburses for certain shortfalls in the borrowers' securities accounts.
Merrill Lynch provides this reimbursement through a financial intermediary.
Merrill Lynch requires borrowers to meet daily collateral calls to ensure that
the securities pledged as down payment are sufficient at all times. Merrill
Lynch believes that its potential for loss under these arrangements is remote.
Accordingly, no liability is recorded in the Condensed Consolidated Financial
Statements.
In addition, Merrill Lynch makes guarantees to counterparties in the form of
standby letters of credit. Merrill Lynch holds marketable securities of $255
million as collateral to secure these guarantees. In addition, standby letters
of credit include $104 million of financial guarantees for which Merrill Lynch
has recourse to the guaranteed party upon draw down.
Further, in conjunction with certain principal-protected mutual funds, Merrill
Lynch guarantees the return of the initial principal investment at the
termination date of the fund. These funds are generally managed based on a
formula that requires the fund to hold a combination of general investments and
highly liquid risk-free assets that, when combined, will result in the return of
principal at the maturity date unless there is a significant market event. At
March 26, 2004 Merrill Lynch's maximum potential exposure to loss with respect
to these guarantees is $569 million assuming that the funds are invested
exclusively in other general investments (i.e., the funds hold no risk-free
assets), and that those other general investments suffer a total loss. As such,
this measure significantly overstates Merrill Lynch's exposure or expected loss
at March 26, 2004. These guarantees meet the SFAS No. 149 definition of
derivatives and, as such, are carried as an asset with a fair value of $20
million at March 26, 2004.
These guarantees and their expiration are summarized at March 26, 2004 as
follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
Maximum
Payout/ Less than 1 1 - 3 3+ - 5 Over 5 Carrying
Notional year years years years Value
- --------------------------------------------------------------------------------------------------------------------
Derivative contracts(1) $976,409 $371,452 $263,921 $210,657 $130,379 $19,269
Liquidity facilities with SPEs(2) 13,999 11,693 2,306 - - 101
Liquidity and default facilities
with SPEs 3,213 1,851 1,074 1 287 101
Residual value guarantees(3)(4) 1,876 80 26 420 1,350 40
Standby letters of credit and other
performance guarantees(5) 1,068 347 92 52 577 (19)
- --------------------------------------------------------------------------------------------------------------------
(1) As noted above, the notional value of derivative contracts is provided
rather than the maximum payout amount, although the notional value should
not be considered as a substitute for maximum payout.
(2) Amounts relate primarily to facilities provided to municipal bond
securitization SPEs. Includes $2.7 billion of guarantees provided to SPEs by
third party financial institutions where Merrill Lynch has agreed to
reimburse the financial institution if losses occur, and has up to one year
to fund losses.
(3) Includes residual value guarantees associated with the Hopewell campus and
aircraft leases of $325 million.
(4) Includes $937 million of reimbursement agreements with the Mortgage 100SM
program.
(5) Includes guarantees related to principal-protected mutual funds.
See Note 13 in the 2003 Annual Report for additional information on guarantees.
26
- --------------------------------------------------------------------------------
NOTE 12. EMPLOYEE BENEFIT PLANS
- --------------------------------------------------------------------------------
Merrill Lynch provides retirement and other postemployment benefits to its
employees worldwide through defined contribution and defined benefit pension
plans and other postretirement benefit plans. These plans vary based on the
country and local practices. Merrill Lynch reserves the right to amend or
terminate these plans at any time. Refer to Note 14 in the 2003 Annual Report
for a complete discussion on employee benefit plans.
Defined Benefit Pension Plans
Pension cost for the three months ended March 26, 2004 and March 28, 2003, for
Merrill Lynch's defined benefit pension plans, included the following
components:
(dollars in millions)
- --------------------------------------------------------------------------------------------
Three Months Ended
------------------------
Mar. 26, Mar. 28,
2004 2003
------- -------
Service cost $12 $11
Interest cost 38 36
Expected return on plan assets (35) (34)
Amortization of unrecognized items and other 3 -
------- -------
Total defined benefit pension cost $18 $13
- --------------------------------------------------------------------------------------------
Merrill Lynch disclosed in its 2003 Annual Report that it expected to contribute
$57 million to its defined benefit pension plans in 2004. Merrill Lynch
periodically updates these estimates, and currently expects to contribute $32
million to its defined benefit pension plans in 2004.
Postretirement Benefits Other Than Pensions
Other postretirement benefits cost for the three months ended March 26, 2004 and
March 28, 2003, included the following components:
(dollars in millions)
- --------------------------------------------------------------------------------------------
Three Months Ended
------------------------
Mar. 26, Mar. 28,
2004 2003
------- -------
Service cost $ 4 $ 4
Interest cost 8 8
Other 2 2
------- -------
Total other postretirement benefits cost $14 $14
- --------------------------------------------------------------------------------------------
Merrill Lynch disclosed in its 2003 Annual Report that it expected to contribute
$19 million to its postretirement benefit plans in 2004. Merrill Lynch does not
expect contributions to differ significantly from amounts previously disclosed.
- --------------------------------------------------------------------------------
NOTE 13. REGULATORY REQUIREMENTS
- --------------------------------------------------------------------------------
Certain U.S. and non-U.S. subsidiaries are subject to various securities and
banking regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the countries in which they operate.
Merrill Lynch's principal regulated subsidiaries are discussed below.
27
Securities Regulation
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a U.S. registered
broker-dealer and futures commission merchant, is subject to the net capital
requirements of Rule 15c3-1 under the Securities Exchange Act of 1934 and the
capital requirements of the Commodities Futures Trading Commission ("CFTC").
Under the alternative method permitted by Rule 15c3-1, the minimum required net
capital, as defined, shall not be less than 2% of aggregate debit items ("ADI")
arising from customer transactions. The CFTC also requires that minimum net
capital should not be less than 4% of segregated and secured requirements. At
March 26, 2004, MLPF&S's regulatory net capital of $2,557 million was
approximately 18.9 % of ADI, and its regulatory net capital in excess of the
minimum required was $2,270 million at 2% of ADI.
Merrill Lynch International ("MLI"), a U.K. regulated investment firm, is
subject to capital requirements of the Financial Services Authority ("FSA").
Financial resources, as defined, must exceed the total financial resources
requirement of the FSA. At March 26, 2004, MLI's financial resources were $6,438
million, exceeding the minimum requirement by $1,083 million.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S.
Government securities, is subject to the capital adequacy requirements of the
Government Securities Act of 1986. This rule requires dealers to maintain liquid
capital in excess of market and credit risk, as defined, by 20% (a 1.2-to-1
capital-to-risk standard). At March 26, 2004, MLGSI's liquid capital of $2,227
million was 232 % of its total market and credit risk, and liquid capital in
excess of the minimum required was $1,075 million.
Banking Regulation
Two subsidiaries of ML & Co., Merrill Lynch Bank USA ("MLBUSA") and Merrill
Lynch Bank & Trust Co. ("MLB&T") are required to maintain capital levels that at
least equal minimum capital levels specified in federal banking laws and
regulations. Failure to meet the minimum levels will result in certain
mandatory, and possibly additional discretionary, actions by the regulators
that, if undertaken, could have a direct material effect on the banks. The
capital levels, defined as the Tier 1 leverage ratio, the Tier 1 risk-based
ratio, and the Total risk-based capital ratio, are calculated as (i) Tier 1
Capital or Total Capital to (ii) average assets or risk-weighted assets. MLBUSA
and MLB&T each exceed the minimum bank regulatory requirement for classification
as a well-capitalized bank for the Tier 1 leverage ratio -- 5%, the Tier 1
risk-based capital ratio -- 6% and the Total risk-based capital ratio -- 10%.
The following table represents the actual capital ratios and amounts for MLBUSA
and MLB&T at March 26, 2004 and December 26, 2003.
(dollars in millions)
- ---------------------------------------------------------------------------------------------------------------------
Mar. 26, 2004 Dec. 26, 2003
- ---------------------------------------------------------------------------------------------------------------------
Tier I leverage (to average assets) Actual Ratio Amount Actual Ratio Amount
------------ ------ ------------ ------
MLBUSA 6.75% $4,640 6.47% $4,480
MLB&T 5.63 863 6.00 857
Tier I capital (to risk-weighted assets)
MLBUSA 10.60 4,640 10.73 4,480
MLB&T 16.92 863 19.18 857
Total capital (to risk-weighted assets)
MLBUSA 11.12 4,867 11.28 4,706
MLB&T 16.94 864 19.20 858
- ---------------------------------------------------------------------------------------------------------------------
28
Merrill Lynch Capital Markets Bank Limited ("MLCMB"), an Ireland-based regulated
bank, is subject to the capital requirements of the Irish Financial Services
Regulatory Authority ("IFSRA"), as well as to those of the State of New York
Banking Department ("NYSBD"), as the consolidated supervisor of its indirect
parent, Merrill Lynch International Finance Corporation ("MLIFC"). MLCMB is
required to meet minimum regulatory capital requirements under EU banking law as
implemented in Ireland by IFSRA. At March 26, 2004, MLCMB's capital ratio was
above the minimum requirement at 12.09% and its financial resources, as defined,
were $1,899 million.
Merrill Lynch International Bank Limited ("MLIB"), a U.K.-based regulated bank,
is subject to the capital requirements of the Financial Services Authority
("FSA") as well as those of the NYSBD as part of the MLIFC group. MLIB is
required to meet minimum regulatory capital requirements under EU banking law as
implemented in the U.K. MLIB's consolidated capital ratio (including its
subsidiary Merrill Lynch Bank (Suisse) S.A.), is above the minimum capital
requirements established by the FSA. At March 26, 2004, MLIB's consolidated
capital ratio was 14.7% and its consolidated financial resources were $2,257
million.
29
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of Merrill Lynch & Co., Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Merrill Lynch & Co., Inc. and subsidiaries ("Merrill Lynch") as of March 26,
2004, and the related condensed consolidated statements of earnings and cash
flows for the three-month periods ended March 26, 2004 and March 28, 2003. These
financial statements are the responsibility of Merrill Lynch's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Merrill Lynch as of December 26, 2003, and the related consolidated statements
of earnings, changes in stockholders' equity, comprehensive income and cash
flows for the year then ended prior to restatement for the adoption of Statement
of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure (not presented herein); and in our
report dated March 1, 2004, we expressed an unqualified opinion on those
consolidated financial statements and included an explanatory paragraph for the
change in accounting method in 2002 for goodwill amortization to conform to SFAS
No. 142, Goodwill and Other Intangible Assets. We also audited the adjustments
described in Note 2 to the condensed consolidated financial statements that were
applied to restate the December 26, 2003 consolidated balance sheet of Merrill
Lynch (not presented herein). In our opinion, such adjustments are appropriate
and have been properly applied and the information set forth in the accompanying
condensed consolidated balance sheet as of December 26, 2003 is fairly stated,
in all material respects, in relation to the restated consolidated balance sheet
from which it has been derived.
/s/ Deloitte & Touche LLP
New York, New York
May 4, 2004
30
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Merrill Lynch & Co., Inc. ("ML & Co." and, together with its subsidiaries,
"Merrill Lynch") is a holding company that, through its subsidiaries, provides
broker-dealer, investment banking, financing, wealth management, advisory, asset
management, insurance, lending, and related products and services on a global
basis. In addition, Merrill Lynch engages in market-making activities on behalf
of its clients and for its own account, as well as in private equity and other
principal investment activities. The financial services industry, in which
Merrill Lynch is a leading participant, is extremely competitive and highly
regulated. This industry and the global financial markets are influenced by
numerous unpredictable factors. These factors include economic conditions,
monetary and fiscal policies, the liquidity of global markets, international and
regional political events, acts of war or terrorism, changes in applicable laws
and regulations, the competitive environment, and investor sentiment. In
addition to these factors, Merrill Lynch and other financial services companies
may be affected by regulatory and legislative initiatives that may affect the
conduct of their business, including increased regulation, and by the outcome of
legal and regulatory investigations and proceedings. These conditions or events
can significantly affect the volatility of the financial markets as well as the
volumes and revenues in businesses such as brokerage, trading, investment
banking, wealth management and asset management. Revenues and net earnings may
vary significantly from period to period due to the unpredictability of these
factors and the resulting market volatility and trading volumes.
The financial services industry continues to be affected by an intensifying
competitive environment, as demonstrated by consolidation through mergers,
competition from new and established competitors, and diminishing margins in
many mature products and services. Commercial and investment bank consolidations
have also increased the competition for investment banking and capital markets
business, due in part to the extension of credit in conjunction with investment
banking and capital raising activities.
The financial services industry is also impacted by the regulatory and
legislative environment. In 2003, additional aspects of the Sarbanes-Oxley Act
of 2002 were implemented as rules relating to corporate governance (including
Board member and Board Committee independence), auditor independence and
disclosure became effective and/or were adopted in their final form. Various
federal and state securities regulators, self-regulatory organizations
(including the New York Stock Exchange and the National Association of
Securities Dealers) and industry participants also continued to review and, in
many cases, adopt changes to their established rules and policies in areas such
as corporate governance, research analyst conflicts of interest and
certifications, practices related to the initial public offering of equity
securities, mutual fund trading, disclosure practices and auditor independence.
Changing requirements for research may continue to affect the cost structure for
such services. Regulatory actions affecting the trading practices and pricing
structure of mutual funds could change the manner in which business is conducted
by the asset management industry. Both inside and outside the United States,
there is continued focus by regulators and legislators on regulatory supervision
of both commercial and investment banks as an industry and on an individual
basis, especially in the areas of capital and risk management.
Forward Looking Statements
Certain statements contained in this report may be considered forward-looking,
including those about management expectations, strategic objectives, business
prospects, anticipated expense levels and financial results, the impact of off
balance sheet arrangements, significant contractual obligations, anticipated
results of litigation and regulatory investigations and proceedings, and other
similar matters. These forward-looking statements represent only Management's
beliefs regarding future performance, which is inherently uncertain. There are a
variety of factors, many of which are beyond Merrill Lynch's control, which
affect its operations, performance, business strategy and results and could
cause its actual results and experience to differ materially from the
expectations and objectives expressed in any forward-looking statements. These
factors include, but are not limited to, the factors listed in the previous
paragraphs, as well as financial market volatility, actions and initiatives
taken by both current and potential competitors, general economic conditions,
the effects of current, pending and future legislation, regulation and
regulatory actions, and the other risks and uncertainties detailed in Merrill
Lynch's Annual Report on Form 10-K for the fiscal year ended December 26, 2003
and in the following sections. Accordingly, readers are cautioned not to place
undue reliance on forward-looking statements, which speak only as of the dates
on which they are made. Merrill Lynch does not undertake to update
forward-looking statements to reflect the impact of circumstances or events that
arise after the dates they are made. The reader should, however, consult any
further disclosures Merrill Lynch may make in future filings of its Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form
8-K.
31
- --------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
- --------------------------------------------------------------------------------
Major equity market indices grew strongly in January and February but, due to
increased geopolitical concerns, weakened in March and ended the quarter
essentially unchanged. Fixed income market conditions continued to be robust.
Despite strong economic growth in 2003, in early 2004, many investors continued
to seek an alternative in bonds amid continued worries about job growth, rising
oil prices and terrorism. The yield curve remained steep. Long-term interest
rates, as measured by the 10-year U.S. Treasury bond, ended the quarter at
3.85%, down from 4.25% at the end of 2003. At its meetings in both January and
March, the U.S. Federal Reserve System's Federal Open Market Committee kept its
target for the federal funds rate unchanged at 1.00%.
Major U.S. equity indices increased steadily early in the first quarter, but due
to a late quarter downturn closed essentially unchanged from the end of 2003.
The Dow Jones Industrial Average finished the quarter down 0.9%, but was up
29.6% from the first quarter of 2003. The Nasdaq Composite, whose many
technology stocks led last year's market gains and this year's declines, fell
0.5% in the first quarter but finished the quarter 48.7% above its prior-year
level. The Standard and Poor's 500 stock index rose 1.3% during the first
quarter but was up 32.8% from the end of the first quarter of 2003.
After last year's powerful rally, global stock markets turned in a mixed
performance for the quarter. The Dow Jones World Index, excluding the United
States, was up 5.6% in the first quarter of 2004 and 58.2% from the first
quarter of 2003. In Europe, the Dow Jones Stoxx Index of 600 European blue-chip
companies increased 3.2% in the quarter with the help of the U.S. dollar
slightly rebounding against the euro. In Japan, the Nikkei 225 index ended the
quarter with an overall gain of 10% and reached a 21-month high by the end of
March. Emerging markets, led by Mexico and South Korea, continued to outperform
most of the developed world.
Global debt and equity underwriting volumes increased to $1.6 trillion, up 26%
from the 2003 fourth quarter and 14% from the first quarter of 2003, according
to Thomson Financial Securities Data. Increased stock issuances helped raise
total underwriting fees to $4.9 billion in the first quarter, the highest level
in two-and-a-half years, according to Thomson Financial Securities Data. The
comeback of Initial Public Offerings ("IPOs"), which earn the highest fees, was
the primary reason for the significant increase in underwriting fees. The 42
IPOs in the first quarter of 2004, which raised $8.3 billion, was the highest
transaction count since the first quarter of 2000.
Global merger and acquisition activity experienced mixed results. Despite strong
dollar volumes of announced deals of $536 billion, the number of announced deals
declined 7% from the fourth quarter of 2003 but was up 6% from the prior-year
quarter. In the United States, the value of announced deals totaled
approximately $292 billion, the highest level since the fourth quarter of 2000,
according to Thomson Financial Securities Data.
Merrill Lynch continually evaluates the profitability and performance of its
businesses under varying market conditions and, in light of the evolving
competitive environment, for alignment with long-term strategic objectives. The
strategy of disciplined growth through maintaining long-term client
relationships, diversifying revenue sources, closely monitoring costs and risks,
and increasing fee-based and recurring revenues all continue as objectives to
mitigate the effects of a volatile market environment on Merrill Lynch's
business as a whole.
32
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
For the Three Months Ended
----------------------------
March 26, March 28,
(dollars in millions, except per share amounts) 2004 2003(1)
- ------------------------------------------------------------------------------------
Net Revenues
Asset management and portfolio service fees $1,315 $1,127
Commissions 1,361 1,069
Principal transactions 1,046 1,025
Investment banking 837 493
Other 367 213
------ ------
Subtotal 4,926 3,927
Interest and dividend revenues 3,061 3,005
Less interest expense 1,897 2,128
------ ------
Net interest profit 1,164 877
------ ------
Total Net Revenues 6,090 4,804
------ ------
Non-interest expenses:
Compensation and benefits 3,047 2,561
Communications and technology 341 403
Occupancy and related depreciation 217 216
Brokerage, clearing, and exchange fees 204 170
Advertising and market development 122 121
Professional fees 177 144
Office supplies and postage 51 58
Other 239 222
------ ------
Total non-interest expenses 4,398 3,895
------ ------
Earnings before income taxes $1,692 $ 909
====== ======
Net earnings $1,252 $ 643
====== ======
Earnings per common share:
Basic $ 1.34 $ 0.71
Diluted 1.22 0.67
Annualized return on average common
stockholders' equity 17.0% 10.5%
Pre-tax profit margin 27.8 18.9
- ------------------------------------------------------------------------------------
Compensation and benefits
as a percentage of net revenues 50.0% 53.3%
Non-compensation expenses
as a percentage of net revenues 22.2 27.8
- ------------------------------------------------------------------------------------
(1) Prior period amounts have been restated to reflect the retroactive adoption
of the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, as discussed in Note 2.
Consolidated Results of Operations
Merrill Lynch's net earnings were $1.3 billion for the 2004 first quarter, an
increase of 95% from $643 million in the first quarter of 2003. Earnings per
common share were $1.34 basic and $1.22 diluted, compared with $0.71 basic and
$0.67 diluted in the 2003 first quarter. The 2004 first quarter pre-tax margin
rose to 27.8%, up from 18.9% in the prior-year quarter.
33
Net revenues were $6.1 billion in the first quarter of 2004, 27% higher than the
2003 first quarter. Asset management and portfolio service fees were $1.3
billion, up 17% from the first quarter of 2003 largely as a result of higher
portfolio servicing fees, a large portion of which are calculated on
beginning-of-period asset values, as well as increased investment and fund
management fees. Commission revenues were $1.4 billion, up 27% from the 2003
first quarter, due to higher transaction volumes, particularly in listed
equities and mutual funds. Principal transactions revenues remained essentially
unchanged from the year-ago quarter, at $1.0 billion. Investment banking
revenues were $837 million, 70% higher than the 2003 first quarter. These
revenues included underwriting revenues of $672 million that were 83% higher
than the 2003 first quarter, reflecting higher levels of equity underwriting
revenues in a more favorable market environment. Also included were strategic
advisory revenues of $165 million, which increased 32% from the year-ago
quarter, as merger and acquisition activity levels increased. Other revenues
were $367 million, 72% higher than the 2003 first quarter due principally to
increased revenues from investments, partially offset by lower realized gains on
the sales of mortgages.
Net interest profit was $1.2 billion, up 33% from the 2003 first quarter, due
primarily to a favorable yield curve environment and increased secured lending
activity. As a result of the deconsolidation of the Trusts that issued Trust
Originated Preferred Securities ("TOPrSSM") in accordance with the adoption of
Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 46R,
net interest profit now includes the interest expense associated with the
long-term debt issued to the TOPrSSM partnerships. See Note 6 to the Condensed
Consolidated Financial Statements for additional information on the impact of
TOPrSSM.
Compensation and benefits expenses of $3.0 billion in the first quarter of 2004
increased 19% from the 2003 first quarter due primarily to higher incentive
compensation accruals reflecting increased net revenues. Compensation and
benefits expenses were 50.0% of net revenues for the first quarter of 2004,
compared to 53.3% in the year-ago quarter. These amounts reflect the retroactive
restatement for stock option expensing under Statement of Financial Accounting
Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, which
amounted to $59 million and $65 million for the first three months of 2004 and
2003, respectively. Stock option grants are amortized into earnings over the
vesting period. See Note 15 to the 2003 Annual Report for additional information
related to stock-based compensation.
Non-compensation expenses were $1.4 billion in the first quarter of 2004,
essentially unchanged from the 2003 first quarter. Communications and technology
costs were $341 million, down 15% from the first quarter of 2003 due primarily
to reduced technology equipment depreciation and rental costs, as well as lower
systems consulting and communications costs. Brokerage, clearing and exchange
fees were $204 million, up 20% from the 2003 first quarter, due to higher
transaction volumes. Professional fees increased 23% from the first quarter of
2003, to $177 million, due principally to increased legal, consulting and
recruitment fees. Other expenses were $239 million in the first quarter of 2004,
up 8% from a year ago. A $45 million expense recorded in the GPC segment for the
adoption of Statement of Position ("SOP") 03-1, Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts, relating to the accounting for death and other insurance
benefits, was partially offset by lower provisions for losses.
Merrill Lynch's first quarter 2004 effective tax rate of 26.0%, declined from
26.5% for the full year of 2003, due primarily to increased lower-taxed earnings
from international operations and additional benefits related to state deferred
tax assets. The tax rate also reflects projected utilization of Japan net
operating losses against Japanese earnings for 2004 and 2003, respectively.
34
- --------------------------------------------------------------------------------
BUSINESS SEGMENTS
- --------------------------------------------------------------------------------
Merrill Lynch reports its results in three business segments: the Global Markets
and Investment Banking Group ("GMI"), Global Private Client ("GPC"), and Merrill
Lynch Investment Managers ("MLIM"). GMI provides capital markets and investment
banking services to corporate, institutional, and governmental clients around
the world. GPC provides global wealth management products and services to
individuals, small- to mid-size businesses, and employee benefit plans. MLIM
provides asset management services to individual, institutional and corporate
clients.
Certain MLIM and GMI products are distributed through GPC distribution channels,
and, to a lesser extent, certain MLIM products are distributed through GMI.
Revenues and expenses associated with these inter-segment activities are
recognized in each segment and eliminated at the corporate level. In addition,
revenue and expense sharing agreements for shared activities between segments
are in place and the results of each segment reflect the agreed-upon portion of
these activities. The following segment results represent the information that
is relied upon by management in its decision-making processes. These results
exclude items reported in the Corporate segment, including the net revenue
impact of TOPrSSM. Business segment results are restated to reflect
reallocations of revenues and expenses, which result from changes in Merrill
Lynch's business strategy and structure.
- --------------------------------------------------------------------------------
GLOBAL MARKETS AND INVESTMENT BANKING
- --------------------------------------------------------------------------------
GMI's Results of Operations
- --------------------------------------------------------------------
For the Three Months Ended
- --------------------------------------------------------------------
Mar. 26, Mar. 28,
(dollars in millions) 2004 2003 % Inc.
- --------------------------------------------------------------------
Commissions $ 552 $ 511 8
Principal transactions and
net interest profit 1,733 1,425 22
Investment banking 675 433 56
Other revenues 275 88 213
------ ------
Total net revenues 3,235 2,457 32
------ ------
Non-interest expenses 2,120 1,708 24
------ ------
Pre-tax earnings $1,115 $ 749 49
------ ------
Pre-tax profit margin 34.5% 30.5%
- --------------------------------------------------------------------
GMI took advantage of favorable market conditions and both Global Markets and
Investment Banking achieved strong year-over-year growth in net revenues and
pre-tax earnings. In debt markets, GMI generated record quarterly net revenues,
driven by increased client activity as a result of continued favorable interest
rate and credit environments as well as selective position-taking. Net revenues
in GMI's equity business also improved significantly across all components of
equity trading, origination and financing activities as volumes and volatility
increased. Geographically, all regions within GMI achieved year-over-year
revenue increases. In Investment Banking, equity origination, debt origination,
and merger and acquisition advisory revenues all increased from the year-ago
quarter.
GMI's pre-tax earnings increased 49% from the first quarter of 2003, to $1.1
billion. GMI's net revenues were $3.2 billion in the 2004 first quarter, 32%
higher than the year-ago quarter. This revenue increase, complemented by ongoing
operating discipline, resulted in a pre-tax margin of 34.5%, up from 30.5% in
the year-ago quarter. Total non-interest expenses were $2.1 billion during the
2004 first quarter, up from $1.7 billion in the year-ago period, due primarily
to higher incentive compensation accruals associated with increased net
revenues.
Commissions
Commission revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, money market instruments and options.
Commission revenues in the first quarter of 2004 increased 8% compared to the
year-ago quarter, to $552 million, primarily as a result of an increase in
global equity trading volumes.
35
Principal transactions and net interest profit
- ----------------------------------------------------------------------
For the Three Months Ended
- ----------------------------------------------------------------------
March 26, March 28,
(dollars in millions) 2004 2003 % Inc.
- ----------------------------------------------------------------------
Debt and debt derivatives $ 1,401 $ 1,253 12
Equities and equity derivatives 332 172 93
------- -------
Total $ 1,733 $ 1,425 22
- ----------------------------------------------------------------------
Principal transactions revenues include realized gains and losses from the
purchase and sale of securities in which Merrill Lynch acts as principal, and
unrealized gains and losses on trading assets and liabilities.
Net interest profit is a function of the level and mix of total assets and
liabilities, including trading assets owned and the prevailing level, term
structure, and volatility of interest rates. Net interest profit is an integral
component of trading and investing activity.
In assessing the profitability of its client facilitation and trading
activities, Merrill Lynch views principal transactions and net interest profit
in the aggregate as net trading revenues. Changes in the composition of trading
inventories and hedge positions can cause the mix of principal transactions and
net interest profit to fluctuate. Net trading revenues were $1.7 billion in the
first quarter of 2004, up 22% from $1.4 billion in the year-ago quarter. Debt
and debt derivatives net trading revenues were $1.4 billion, 12% higher than the
first quarter of 2003, reflecting increased trading of interest rate and credit
products due to a favorable yield curve environment and selective
position-taking. Equities and equity derivatives net trading revenues increased
93% from the first quarter of 2003 to $332 million, due to higher trading
revenues resulting from the improvement in market conditions across equity and
equity-related products.
Investment Banking
- --------------------------------------------------------------------
For the Three Months Ended
- --------------------------------------------------------------------
Mar. 26, Mar. 28,
(dollars in millions) 2004 2003 % Inc.
- --------------------------------------------------------------------
Debt underwriting $ 236 $ 176 34
Equity underwriting 276 132 109
----- ----- ---
Total underwriting 512 308 66
----- -----
Strategic advisory services 163 125 30
----- ----- ---
Total $ 675 $ 433 56
- --------------------------------------------------------------------
Underwriting
- ------------
Underwriting revenues represent fees earned from the underwriting of debt and
equity and equity-linked securities as well as loan syndication and commitment
fees.
Underwriting revenues in the 2004 first quarter were $512 million, up 66% from
the $308 million recorded in the year-ago quarter, due to increased equity and
debt underwriting revenues resulting from a higher volume of transactions.
Merrill Lynch increased its market shares in most categories from a year ago and
ranked second in global debt and equity underwriting in the first quarter of
2004.
36
Merrill Lynch's underwriting market share information based on transaction
value follows:
- ----------------------------------------------------------------------------------------
For the Three Months Ended
-------------------------------------------------
March 26, 2004 March 28, 2003
---------------- -----------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Global proceeds
Debt and Equity 8.1% 2 7.1% 3
Debt 8.1 2 7.1 3
Equity and equity-linked 8.8 4 8.0 5
U.S. proceeds
Debt and Equity 11.4% 2 9.1% 2
Debt 11.6 2 9.1 2
Equity and equity-linked 8.1 4 14.6 1
- ----------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to book manager.
Strategic Advisory Services
- ---------------------------
Strategic advisory services revenues, which include merger and acquisition and
other advisory fees, were $163 million in the first quarter of 2004, up 30% from
the first quarter of 2003 as market shares both in the U.S. and globally,
increased.
Merrill Lynch's merger and acquisition market share information based on
transaction value is as follows:
- ----------------------------------------------------------------------------------------
For the Three Months Ended
------------------------------------------------
March 26, 2004 March 28, 2003
--------------- ---------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Completed transactions
Global 18.4% 2 15.2% 3
U.S. 33.8 1 23.8 3
Announced transactions
Global 23.8% 4 13.4% 5
U.S. 18.3 10 3.7 13
- ----------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to both target
and acquiring companies' advisors.
Other Revenues
Other revenues, which include realized investment gains and losses, income from
equity method investments and distributions on equity investments, were $275
million in the first quarter of 2004 compared to $88 million in the year-ago
quarter, due primarily to increased net revenues related to equity method and
other investments. Other revenues in the 2004 first quarter included $57 million
from an equity-method investment in an entity which focuses on managing problem
loans to small and medium-size companies in Japan.
For additional information on GMI's segment results, refer to Note 4 to the
Condensed Consolidated Financial Statements.
37
- --------------------------------------------------------------------------------
GLOBAL PRIVATE CLIENT
- --------------------------------------------------------------------------------
GPC's Results of Operations
- --------------------------------------------------------------------------
For the Three Months Ended
- --------------------------------------------------------------------------
Mar. 26, Mar. 28, % Inc.
(dollars in millions) 2004 2003 (Dec.)
- --------------------------------------------------------------------------
Asset management and
portfolio service fees $ 948 $ 812 17
Commissions 788 538 46
Principal transactions and
new issue revenues 333 299 11
Net interest profit 339 324 5
Other revenues 92 130 (29)
------ ------
Total net revenues 2,500 2,103 19
------ ------
Non-interest expenses 1,990 1,854 7
------ ------
Pre-tax earnings $ 510 $ 249 105
------ ------
Pre-tax profit margin 20.4% 11.8%
- --------------------------------------------------------------------------
GPC's first quarter 2004 pre-tax earnings were $510 million, up 105% from the
2003 first quarter. Net revenues increased 19% from the year-ago quarter to $2.5
billion. The net revenues and pre-tax earnings growth from the prior-year
quarter reflected increased client transaction activity, continued strength in
revenues from fee-based products and increased revenues from distribution of new
issues. GPC's pre-tax margin was 20.4%, up from 11.8% in the year-ago quarter.
Non-interest expenses were $2.0 billion in the first quarter of 2004, 7% higher
than in the first quarter of 2003, primarily due to higher incentive
compensation accruals associated with increased net revenues. Non-compensation
expenses included a $45 million expense related to the adoption of SOP 03-1
relating to the accounting for guaranteed minimum death benefits in variable
annuity products.
GPC employed approximately 13,700 Financial Advisors at the end of the 2004
first quarter, a net increase of approximately 100 from the end of the year-ago
quarter.
Asset management and portfolio service fees
Asset management and portfolio service fees include asset management fees from
taxable and tax-exempt money market funds as well as portfolio fees from
fee-based accounts such as Unlimited AdvantageSM and Merrill Lynch Consults(R).
Also included are servicing fees related to these accounts, and certain other
account-related fees.
Asset management and portfolio service fees totaled $948 million, up 17% from
the $812 million recorded in the first quarter of 2003. This increase reflects
higher portfolio servicing fees, a large portion of which are calculated on
beginning-of-period asset values.
Commissions
Commissions revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, as well as sales of mutual funds, insurance
products, and options.
Commissions revenues increased 46% to $788 million in the first quarter of 2004
from $538 million in the year-ago quarter, due primarily to increased
transaction volumes related to mutual funds and equities.
38
Principal transactions and new issue revenues
GPC's principal transactions and new issue revenues primarily represent
bid-offer revenues in over-the-counter equity securities, government bonds and
municipal securities, as well as selling concessions on underwriting of debt and
equity products.
Principal transactions and new issue revenues were $333 million, 11% higher than
the 2003 first quarter due to an increase in equity new issue revenues.
An analysis of changes in assets in GPC accounts from March 28, 2003 to March
26, 2004 is detailed below:
- -----------------------------------------------------------------------------------------------------
Net Changes Due To
---------------------------------------
March 28, New Asset March 26,
(dollars in billions) 2003 Money Appreciation Other(1) 2004
- -----------------------------------------------------------------------------------------------------
Assets in GPC accounts
U.S. $1,009 $13 $165 $ - $1,187
Non U.S. 86 2 20 (3) 105
-------------------------------------------------------------
Total $1,095 $15 $185 $(3) $1,292
- -----------------------------------------------------------------------------------------------------
(1) Represents accounts sold as part of the sale of GPC's call center in Japan
and the divestiture of the German business.
Total assets in GPC accounts in the United States were $1.2 trillion at March
26, 2004 up from $1.0 trillion at the end of the 2003 first quarter as a result
of market-driven increases in asset values and net new money of $13 billion.
Outside the United States, client assets were $105 billion, up from $86 billion
at the end of the year-ago quarter, largely due to market-driven increases.
Total assets in asset-priced accounts were $235 billion at the end of the 2004
first quarter, up 30% from $181 billion at the end of the 2003 first quarter.
Net interest profit
Net interest profit for GPC includes GPC's allocation of the interest spread
earned in Merrill Lynch's banks for deposits as well as interest earned on
margin and other loans. Net interest profit was $339 million in the 2004 first
quarter, up 5% from $324 million in the first quarter of 2003.
Other revenues
Other revenues were $92 million in the first quarter of 2004, compared to $130
million in the year-ago period. This decline is due principally to lower
realized gains on the sales of mortgages.
For additional information on GPC's segment results, refer to Note 4 to the
Condensed Consolidated Financial Statements.
39
- --------------------------------------------------------------------------------
MERRILL LYNCH INVESTMENT MANAGERS
- --------------------------------------------------------------------------------
MLIM's Results of Operations
- --------------------------------------------------------------------------
- --------------------------------------------------------------------------
For the Three Months Ended
- --------------------------------------------------------------------------
March 26, March 28,
(dollars in millions) 2004 2003 % Inc.
- --------------------------------------------------------------------------
Asset management fees $ 356 $ 300 19
Commissions 32 31 3
Other revenues 24 6 300
----- -----
Total net revenues 412 337 22
Non-interest expenses 301 298 1
----- -----
Pre-tax earnings $ 111 $ 39 185
----- -----
Pre-tax profit margin 26.9 % 11.6 %
- --------------------------------------------------------------------------
MLIM continued to demonstrate strong relative investment performance for the 1-,
3- and 5-year periods ended March 2004. For each of these periods, more than 70%
of MLIM's global assets under management were ahead of their benchmark or
category median.
MLIM's pre-tax earnings in the 2004 first quarter were $111 million, up 185%
from $39 million in the 2003 first quarter on net revenues that increased 22%
from the year ago period to $412 million. This increase is due primarily to
higher net asset values and net inflows. Net revenues are primarily dependent on
levels of assets under management and asset mix. Non-interest expenses remained
essentially unchanged from the year-ago period, at $301 million primarily
reflecting continued expense management. The pre-tax margin was 26.9% in the
first quarter of 2004, up over 15 percentage points from 11.6% in the year-ago
quarter.
Asset management fees
Asset management fees primarily consist of fees earned from the management and
administration of funds and separately managed accounts. In some cases,
separately managed accounts will, in addition, generate performance fees. Asset
management fees were $356 million, up 19% from $300 million in the first quarter
of 2003 due primarily to higher market values. At the end of the first quarter
of 2004, assets under management totaled $513 billion, a 16% increase from $442
billion at the end of the year-ago quarter, due primarily to market-driven
appreciation, the positive impact of foreign exchange, and net new money inflows
of $7 billion.
Commissions
Commissions for MLIM principally consist of distribution fees and redemption
fees related to mutual funds. The distribution fees represent revenues earned
for promoting and distributing mutual funds ("12b-1 fees"). Commissions remained
essentially unchanged at $32 million compared to the year-ago quarter.
An analysis of changes in assets under management from March 28, 2003 to March
26, 2004 is as follows:
- -----------------------------------------------------------------------------------------------------------
Net Changes Due To
-------------------------------------------
March 28, New Asset March 26,
(dollars in billions) 2003 Money Appreciation Other(1) 2004
- -----------------------------------------------------------------------------------------------------------
Assets under management $442 $7 $40 $24 $513
- -----------------------------------------------------------------------------------------------------------
(1) Includes reinvested dividends, the impact of foreign exchange movements, net
outflows of retail money market funds and other changes.
40
Other Revenues
Other revenues, which primarily include net interest profit and investment gains
and losses, totaled $24 million and $6 million for the first quarter of 2004 and
2003, respectively. This increase is due primarily to consolidation of certain
investments in accordance with FIN 46.
For additional information on MLIM's segment results, refer to Note 4 to the
Condensed Consolidated Financial Statements.
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
Management continually monitors and evaluates the size and composition of the
Consolidated Balance Sheet. The following table summarizes the March 26, 2004
and December 26, 2003 period-end, and first quarter 2004 and full-year 2003
average balance sheets:
(dollars in billions)
- -----------------------------------------------------------------------------------------------------------------------
Mar. 26, 2004 Quarterly Dec. 26, 2003 Full year
2004 Average(1) 2003 Average(1)
- -----------------------------------------------------------------------------------------------------------------------
Assets
Trading-Related
Securities financing assets $136.1 $153.4 $126.4 $145.0
Trading assets 141.7 154.7 134.3 135.9
Other trading-related receivables 51.0 50.7 46.5 50.5
------ ------ ------ ------
328.8 358.8 307.2 331.4
------ ------ ------ ------
Non-Trading-Related
Cash 27.0 29.6 25.3 24.6
Investment securities 79.9 78.2 74.8 78.5
Loans, notes, and mortgages 49.9 53.0 51.0 44.8
Other non-trading assets 39.4 38.6 38.0 41.4
------ ------ ------ ------
196.2 199.4 189.1 189.3
------ ------ ------ ------
Total assets $525.0 $558.2 $496.3 $520.7
====== ====== ====== ======
Liabilities
Trading-Related
Securities financing liabilities $128.2 $156.9 $116.4 $137.7
Trading liabilities 98.6 96.5 89.3 93.7
Other trading-related payables 44.3 54.2 49.2 55.5
------ ------ ------ ------
271.1 307.6 254.9 286.9
------ ------ ------ ------
Non-Trading-Related
Commercial paper and
other short-term borrowings 4.6 8.3 5.0 4.9
Deposits 78.1 79.7 79.5 81.2
Long-term borrowings 96.9 91.8 83.3 80.3
Long-term debt issued to TOPrSSM
partnerships 3.2 3.2 3.2 3.2
Other non-trading liabilities 40.9 38.0 41.4 38.0
------ ------ ------ ------
223.7 221.0 212.4 207.6
------ ------ ------ ------
Total liabilities 494.8 528.6 467.3 494.5
Total stockholders' equity 30.2 29.6 29.0 26.2
------ ------ ------ ------
Total liabilities and stockholders' equity $525.0 $558.2 $496.3 $520.7
- -----------------------------------------------------------------------------------------------------------------------
(1) Averages represent management's daily balance sheet estimates, which may not
fully reflect netting and other adjustments included in period-end balances.
Balances for certain assets and liabilities are not revised on a daily basis.
41
- --------------------------------------------------------------------------------
OFF BALANCE SHEET ARRANGEMENTS
- --------------------------------------------------------------------------------
As a part of its normal operations, Merrill Lynch enters into various off
balance sheet arrangements that may require future payments. The table below
outlines the significant off balance sheet arrangements, as well as the future
expiration as of March 26, 2004:
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------------------
Expiration
-------------------------------------------------------------------
Less than 1-3 3+ -5 Over 5
Total 1 Year Years Years Years
- -------------------------------------------------------------------------------------------------------------------------
Liquidity facilities with SPEs(1) $13,999 $11,693 $ 2,306 $ - $ -
Liquidity and default facilities with SPEs (1) 3,213 1,851 1,074 1 287
Residual value guarantees (2)(3) 1,876 80 26 420 1,350
Standby letters of credit and other
performance guarantees 1,068 347 92 52 577
Contractual agreements (4) 45,628 10,074 10,502 5,224 19,828
Commitments to extend credit 43,583 19,887 10,107 7,824 5,765
Resale agreements 14,821 14,821 - - -
- -------------------------------------------------------------------------------------------------------------------------
(1) Amounts relate primarily to facilities provided to municipal bond securitization SPEs.
(2) Includes residual value guarantees associated with the Hopewell campus and aircraft leases of $325 million.
(3) Includes $937 million of reimbursement agreements with the Mortgage 100SM program.
(4) Represents the liability balance of contractual agreements at March 26, 2004.
In April 2004, Merrill Lynch entered into a commitment to extend a 5.3 billion
Euro loan to Sanofi-Synthelabo, a large French pharmaceutical company, in
connection with its acquisition of Aventis. This commitment replaces the
previously reported four billion Euro commitment entered into in January 2004.
Merrill Lynch intends to syndicate out a significant portion of this commitment
prior to funding. Commitments to extend credit at March 26, 2004, include $1.9
billion related to this commitment.
Refer to Note 11 to the Condensed Consolidated Financial Statements for
additional information.
- --------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS
- --------------------------------------------------------------------------------
In the normal course of business, Merrill Lynch enters into various contractual
obligations that may require future cash payments. The accompanying table
summarizes Merrill Lynch's contractual obligations by remaining maturity at
March 26, 2004. Excluded from this table are obligations recorded on the
Condensed Consolidated Balance Sheet that are generally short-term in nature,
including securities financing transactions, trading liabilities, deposits,
commercial paper and other short-term borrowings and other payables. Also
excluded are obligations that are related to our insurance subsidiaries,
including liabilities of insurance subsidiaries, which are subject to
significant variability and separate accounts liabilities, which fund separate
accounts assets.
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------------
Expiration
-------------------------------------------------------------------
Less than 1-3 3+ -5 Over 5
Total 1 Year Years Years Years
- -----------------------------------------------------------------------------------------------------------------
Long-term borrowings (1) $100,110 $23,041 $24,475 $25,894 $26,700
Operating lease commitments 3,809 525 1,010 845 1,429
Purchasing and other commitments 8,663 7,408 570 449 236
- -----------------------------------------------------------------------------------------------------------------
(1) Includes Long-term debt issued to TOPrSSM partnerships.
42
- --------------------------------------------------------------------------------
CAPITAL ADEQUACY AND FUNDING
- --------------------------------------------------------------------------------
The primary objectives of Merrill Lynch's capital structure and funding policies
are to support the successful execution of the firm's business strategies while
ensuring:
o sufficient equity capital to absorb losses and,
o liquidity at all times, across market cycles, and through periods of financial
stress.
These objectives and Merrill Lynch's capital structure and funding policies are
discussed more fully in the Annual Report on Form 10-K for the year ended
December 26, 2003.
Capital Adequacy
At March 26, 2004, Merrill Lynch's equity capital was comprised of $29.8 billion
in common equity, $425 million in preferred stock, and $2.6 billion of Long-term
debt issued to TOPrSSM partnerships (net of related investments). Based on the
risks and equity needs of its businesses, Merrill Lynch believes that its equity
capital base of $32.8 billion is adequate.
Asset-to-equity leverage ratios are commonly used to assess a company's
capital adequacy. Merrill Lynch believes that a leverage ratio adjusted to
exclude certain assets considered to have a low risk profile provides a more
meaningful measure of balance sheet leverage in the securities industry than an
unadjusted ratio. Merrill Lynch's unadjusted and adjusted leverage ratios are
shown below. When assessing its capital adequacy, Merrill Lynch considers the
risk profile of assets, the impact of hedging, off balance sheet exposures,
operational risk and other considerations, and does not emphasize leverage
ratios, which are not risk sensitive.
The following table provides calculations of Merrill Lynch's leverage
ratios:
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------
March 26, 2004 December 26, 2003
- -------------------------------------------------------------------------------------------------------------
Total assets $524,997 $496,316
Less:
Receivables under resale agreements 76,743 71,756
Receivables under securities borrowed transactions 51,076 45,472
Securities received as collateral 8,307 9,156
-------- --------
Adjusted assets $388,871 $369,932
-------- --------
Stockholders' equity $ 30,187 $ 28,950
Long-term debt issued to TOPrSSM partnerships, net of
related investments (1) 2,628 2,629
-------- --------
Equity capital $ 32,815 $ 31,579
-------- --------
Leverage ratio(2) 16.0x 15.7x
Adjusted leverage ratio(3) 11.9x 11.7x
- -------------------------------------------------------------------------------------------------------------
(1) Due to the perpetual nature of TOPrSSM and other considerations, Merrill
Lynch views the Long-term debt issued to TOPrSSM partnerships net of the
related investments as a component of equity capital, however the Long-term
debt issued to the TOPrSSM partnerships is reported as a liability for
accounting purposes. TOPrSSM-related investments were $574 million at
March 26, 2004 and December 26, 2003.
(2) Total assets divided by equity capital.
(3) Adjusted assets divided by equity capital.
As part of Merrill Lynch's capital management, the board of directors authorized
the repurchase of up to $2 billion of outstanding common shares under a program
announced on February 10, 2004. During the quarter ended March 26, 2004, Merrill
Lynch repurchased 8.2 million shares of common stock at a cost of $502 million.
For more information on the share repurchase plan see Part II - Item 2.
43
Funding
Commercial paper outstanding totaled $3.8 billion at March 26, 2004 and $4.6
billion at December 26, 2003, which was approximately 4% and 5% of total
unsecured borrowings at March 26, 2004 and year-end 2003, respectively. Deposits
at Merrill Lynch's banking subsidiaries totaled $78.1 billion at March 26, 2004,
down from $79.5 billion at year-end 2003. Of the $78.1 billion of deposits in
Merrill Lynch banking subsidiaries as of March 26, 2004, $65.4 billion were in
U.S. banks. Outstanding Long-term borrowings, including Long-term debt issued to
TOPrSSM partnerships, increased to $100.1 billion at March 26, 2004 from $86.5
billion at December 26, 2003. The increase in Long-term borrowings supported
higher asset levels and was consistent with Merrill Lynch's liquidity practices.
For capital management purposes, Merrill Lynch views TOPrSSM as a component of
equity capital however, the Long-term debt issued to the TOPrSSM partnerships is
reported as a liability for accounting purposes. For additional information on
the accounting for TOPrSSM, refer to Note 5 of the Condensed Consolidated
Financial Statements. Major components of the change in long-term borrowings
during the first three months of 2004 are as follows:
(dollars in billions)
- -------------------------------------------------------
Balance at December 26, 2003 $ 86.5
Issuances 18.3
Maturities (4.8)
Other, net 0.1
------
Balance at March 26, 2004 (1) $100.1
- ----------------------------------------- --------------
(1) At March 26, 2004, $77.1 billion of long-term borrowings had maturity dates
beyond one year.
As a part of its overall liquidity risk management practices, Merrill Lynch
seeks to ensure availability of sufficient alternative funding sources to enable
the repayment of all unsecured debt obligations maturing within one year without
issuing new unsecured debt or requiring liquidation of business assets. The main
alternative funding sources to unsecured borrowings are repurchase agreements,
securities loaned, and other secured borrowings, which require pledging
unencumbered securities held for trading or investment purposes.
Merrill Lynch also maintains a separate liquidity portfolio of U.S. Government
and agency obligations and other instruments of high credit quality that is
funded with debt with an average maturity greater than one year. The carrying
value of this portfolio, net of related hedges, was $14.9 billion and $14.6
billion at March 26, 2004 and December 26, 2003, respectively. These assets may
be sold or pledged to provide immediate liquidity to ML & Co. to repay maturing
debt obligations. In addition to this portfolio, the firm monitors the extent to
which other unencumbered assets are available to ML & Co. as a source of funds
considering that some subsidiaries are restricted in their ability to upstream
unencumbered collateral to ML & Co.
Merrill Lynch also maintains a committed, multi-currency, unsecured bank credit
facility that totaled $3.0 billion at March 26, 2004 and December 26, 2003. The
facility, which expires in May 2004, is expected to be renewed. At March 26,
2004 and December 26, 2003, there were no borrowings under this credit facility,
although ML & Co. may borrow from this facility from time to time.
Credit Ratings
The cost and availability of unsecured funding are impacted by credit ratings
and market conditions. In addition, credit ratings are important when competing
in certain markets and when seeking to engage in long-term transactions
including over-the-counter derivatives. Factors that influence Merrill Lynch's
credit ratings include the rating agencies' assessment of the general operating
environment, Merrill Lynch's relative positions in the markets in which it
competes, reputation, level and volatility of earnings, risk management
policies, liquidity and capital management.
44
Merrill Lynch's senior long-term debt and preferred stock were rated by several
recognized credit rating agencies at May 4, 2004 as indicated below. These
ratings do not reflect outlooks that may be expressed by the rating agencies
from time to time, which are currently stable.
- ------------------------------------------------------------------------------------------
Preferred
Rating Agency Senior Debt Ratings Stock Ratings
- ------------------------------------------------------------------------------------------
Dominion Bond Rating Service Ltd AA (low) Not Rated
Fitch Ratings AA- A+
Moody's Investors Service, Inc. Aa3 A2
Rating and Investment Information, Inc. (1) AA A+
Standard & Poor's Ratings Services A+ A-
- ------------------------------------------------------------------------------------------
(1) Located in Japan
- --------------------------------------------------------------------------------
RISK MANAGEMENT
- --------------------------------------------------------------------------------
Risk-taking is an integral part of Merrill Lynch's core business activities. In
the course of conducting its business operations, Merrill Lynch is exposed to a
variety of risks. These risks include market, credit, liquidity, process, and
other risks that are material and require comprehensive controls and management.
The responsibility and accountability for these risks remain primarily with the
individual business units. For a full discussion of Merrill Lynch's risk
management framework, see the 2003 Annual Report on Form 10-K.
Market Risk
Value-at-risk ("VaR") is an estimate within a specified degree of confidence of
the amount that Merrill Lynch's present portfolios could lose over a given time
interval. Merrill Lynch's overall VaR is less than the sum of the VaRs for
individual risk categories because movements in different risk categories occur
at different times and, historically, extreme movements have not occurred in all
risk categories simultaneously. The difference between the sum of the VaRs for
individual risk categories and the VaR calculated for all risk categories is
shown in the following tables and may be viewed as a measure of the
diversification within Merrill Lynch's portfolios. Merrill Lynch believes that
the tabulated risk measures provide some guidance as to the amount Merrill Lynch
could lose in future periods and it works continuously to improve the
methodology and measurement of its VaR. However, like all statistical measures,
especially those that rely heavily on historical data, VaR needs to be
interpreted with a clear understanding of its assumptions and limitations.
The Merrill Lynch VaR system uses a historical simulation approach to estimate
VaR across several confidence levels and holding periods. Sensitivities to
market risk factors are aggregated and combined with a database of historical
weekly changes in market factors to simulate a series of profits and losses. The
level of loss that is exceeded in that series 5% of the time is used as the
estimate for the 95% confidence level VaR. The tables below show VaR using a 95%
confidence level and a weekly holding period for trading and non-trading
portfolios. In addition to the overall VaR, which reflects diversification in
the portfolio, VaR amounts are presented for major risk categories, including
exposure to volatility risk found in certain products, e.g., options. The table
that follows presents Merrill Lynch's VaR for its trading portfolios at March
26, 2004 and December 26, 2003 as well as daily average VaR for the three months
ended March 26, 2004 and full year 2003.
45
- ------------------------------------------------------------------------------------------------------------------
Daily Daily
Mar. 26, Dec. 26, High Low Average Average
(dollars in millions) 2004 2003 1Q04 1Q04 1Q04 2003
- ------------------------------------------------------------------------------------------------------------------
Trading value-at-risk(1)
Interest rate and credit spread $ 53 $ 68 $ 97 $ 38 $ 63 $ 56
Equity 52 34 53 20 33 30
Commodity - 1 2 - 1 1
Currency - 2 12 - 2 2
Volatility 21 36 51 19 39 26
-----------------------------------------------------------------
126 141 138 115
Diversification benefit (46) (62) (68) (54)
---------------- ----------------
Overall(2) $ 80 $ 79 $103 $ 42 $ 70 $ 61
================ ================
- ------------------------------------------------------------------------------------------------------------------
(1) Based on a 95% confidence level and a one-week holding period.
(2) Overall VaR using a 95% confidence level and a one-day holding period was
$28 million at March 26, 2004 and $30 million at year-end 2003.
Merrill Lynch has increased and, if market conditions remain favorable, may
continue to increase its risk taking in a number of growth areas, including
certain lending businesses, proprietary trading activities and principal
investments. These activities provide growth opportunities while also increasing
the loss potential under certain market conditions. Corporate Risk Management
monitors these risk levels on a daily basis to ensure they remain within
corporate risk guidelines and tolerance levels.
The following table presents Merrill Lynch's VaR for its non-trading portfolios,
including Merrill Lynch's U.S. banks, certain middle-market lending activities,
Merrill Lynch's LYONs(R) and TOPrSSM liabilities:
- --------------------------------------------------------------------------
Mar. 26, Dec. 26,
(dollars in millions) 2004 2003
- --------------------------------------------------------------------------
Non-trading value-at-risk(1)
Interest rate and credit spread $ 100 $ 94
Equity 58 56
Currency 18 14
Volatility 20 21
----- -----
196 185
Diversification benefit (56) (67)
----- -----
Overall $ 140 $ 118
===== =====
- --------------------------------------------------------------------------
(1) Based on a 95% confidence level and a one-week holding period.
Credit Risk
Merrill Lynch enters into International Swaps and Derivatives Association, Inc.
master agreements or their equivalent ("master netting agreements") with
substantially all of its derivative counterparties as soon as possible. The
agreements are negotiated with each counterparty and are complex in nature.
While every effort is taken to execute such agreements, it is possible that a
counterparty may be unwilling to sign such an agreement, and as a result, would
subject Merrill Lynch to additional credit risk. Master netting agreements
provide protection in bankruptcy in certain circumstances and, in some cases,
enable receivables and payables with the same counterparty to be offset on the
Consolidated Balance Sheets, providing for a more meaningful balance sheet
presentation of credit exposure. However, the enforceability of master netting
agreements under bankruptcy laws in certain countries or in certain industries
is not free from doubt and receivables and payables with counterparties in these
countries or industries are accordingly recorded on a gross basis.
46
In addition, to reduce default risk, Merrill Lynch requires collateral,
principally cash and U.S. Government and agency securities, on certain
derivative transactions. From an economic standpoint, Merrill Lynch evaluates
default risk exposures net of related collateral. The following is a summary of
counterparty credit ratings for the replacement cost (net of $14.3 billion of
collateral) of OTC trading derivatives in a gain position by maturity at March
26, 2004. (Please note that the following table is inclusive of credit exposure
from derivative transactions only and does not include other material credit
exposures).
(dollars in millions)
- -------------------------------------------------------------------------------------------
Credit Years to Maturity Cross-
--------------------------------------------- Maturity
Rating(1) 0-3 3+- 5 5+- 7 Over 7 Netting(2) Total
- -------------------------------------------------------------------------------------------
AAA $ 1,165 $ 1,051 $ 463 $ 1,255 $ (786) $ 3,148
AA 2,189 964 810 2,243 (1,815) 4,391
A 1,700 854 549 3,552 (1,103) 5,552
BBB 1,272 700 410 997 (898) 2,481
Other 1,651 221 105 341 (343) 1,975
-----------------------------------------------------------------------------
Total $ 7,977 $ 3,790 $ 2,337 $ 8,388 $ (4,945) $ 17,547
- -------------------------------------------------------------------------------------------
(1) Represents credit rating agency equivalent of internal credit ratings.
(2) Represents netting of payable balances with receivable balances for the same
counterparty across maturity band categories. Receivable and payable
balances with the same counterparty in the same maturity category, however,
are net within the maturity category.
In addition to obtaining collateral, Merrill Lynch attempts to mitigate its
default risk on derivatives whenever possible by entering into transactions with
provisions that enable Merrill Lynch to terminate or reset the terms of its
derivative contracts.
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS
- --------------------------------------------------------------------------------
Non-investment grade holdings and highly leveraged transactions involve risks
related to the creditworthiness of the issuers or counterparties and the
liquidity of the market for such investments. Merrill Lynch recognizes that
these risks are inherent in the business and may employ strategies to mitigate
exposures. The specific components and overall level of non-investment grade and
highly-leveraged positions may vary significantly from period to period as a
result of inventory turnover, investment sales, and asset redeployment.
In the normal course of business, Merrill Lynch underwrites, trades, and holds
non-investment grade cash instruments in connection with its investment banking,
market-making, and derivative structuring activities. Non-investment grade
holdings have been defined as debt and preferred equity securities rated lower
than BBB, or equivalent ratings by recognized credit rating agencies, sovereign
debt in emerging markets, amounts due under derivative contracts from
non-investment grade counterparties, and other instruments that, in the opinion
of management, are non-investment grade.
47
In addition to the amounts included in the following table, derivatives may also
expose Merrill Lynch to credit risk related to the underlying security where a
derivative contract either synthesizes ownership of the underlying security
(e.g., long total return swaps) or can potentially force ownership of the
underlying security (e.g., short put options). Derivatives may also subject
Merrill Lynch to credit spread or issuer default risk, in that changes in credit
spreads or in the credit quality of the underlying securities may adversely
affect the derivatives' fair values. Merrill Lynch may seek to mitigate these
risks in certain circumstances by engaging in various hedging strategies to
reduce its exposure associated with non-investment grade positions, such as
purchasing an option to sell the related security or entering into other
offsetting derivative contracts.
Merrill Lynch provides financing and advisory services to, and invests in,
companies entering into leveraged transactions, which may include leveraged
buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch provides
extensions of credit to leveraged companies in the form of senior and
subordinated debt, as well as bridge financing on a select basis. In addition,
Merrill Lynch may syndicate loans for non-investment grade companies or in
connection with highly leveraged transactions and may retain a residual portion
of these loans.
Merrill Lynch holds direct equity investments in leveraged companies and
interests in partnerships that invest in leveraged transactions. Merrill Lynch
has also committed to participate in limited partnerships that invest in
leveraged transactions. Future commitments to participate in limited
partnerships and other direct equity investments will be made on a select basis.
- --------------------------------------------------------------------------------
TRADING EXPOSURES
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's trading exposure to
non-investment grade or highly leveraged issuers or counterparties:
(dollars in millions)
- ---------------------------------------------------------------------------------
Mar. 26, 2004 Dec. 26, 2003
- ---------------------------------------------------------------------------------
Trading assets:
Cash instruments $11,407 $8,331
Derivatives 5,221 4,124
Trading liabilities - cash instruments (3,075) (2,024)
Collateral on derivative assets (3,246) (2,335)
------- ------
Net trading asset exposure $10,307 $8,096
- ---------------------------------------------------------------------------------
Included in the preceding table are debt and equity securities and bank loans of
companies in various stages of bankruptcy proceedings or in default. At March
26, 2004, the carrying value of such debt and equity securities totaled $264
million, of which 18% resulted from Merrill Lynch's market-making activities in
such securities. This compared with $259 million at December 26, 2003, of which
18% related to market-making activities. Also included are distressed bank loans
totaling $189 million and $143 million at March 26, 2004 and December 26, 2003,
respectively.
48
- --------------------------------------------------------------------------------
NON-TRADING EXPOSURES
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's non-trading exposures to
non-investment grade or highly leveraged corporate issuers or counterparties:
(dollars in millions)
- --------------------------------------------------------------------------------------
Mar. 26, 2004 Dec. 26, 2003
- --------------------------------------------------------------------------------------
Investment securities $ 338 $ 183
Loans, notes and mortgages - commercial (1)(2) 10,159 8,344
Other investments(3):
Partnership interests 896 902
Other equity investments (4) 707 716
- --------------------------------------------------------------------------------------
(1) Includes accrued interest. Net of allowance for loan losses.
(2) Includes $9.3 billion and $7.7 billion of secured loans at March 26, 2004
and December 26, 2003, respectively.
(3) Includes a total of $540 million and $508 million in investments at
March 26, 2004 and December 26, 2003, respectively, related to deferred
compensation plans, for which a portion of the default risk of the investments
rests with the participating employees.
(4) Includes investments in 207 and 204 enterprises at March 26, 2004 and
December 26, 2003, respectively.
The following table summarizes Merrill Lynch's commitments with exposure to
non-investment grade or highly-leveraged counterparties:
(dollars in millions)
- ---------------------------------------------------------------------------------------------------
Mar. 26, 2004 Dec. 26, 2003
- ---------------------------------------------------------------------------------------------------
Additional commitments to invest in partnerships (1) $ 406 $ 426
Unutilized revolving lines of credit and other lending commitments 6,610 4,860
- ---------------------------------------------------------------------------------------------------
(1) Includes $136 million and $150 million at March 26, 2004 and December 26,
2003,respectively, related to deferred compensation plans.
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- --------------------------------------------------------------------------------
The following is a summary of Merrill Lynch's critical accounting policies. For
a full description of these and other accounting policies see Note 1 of the 2003
Annual Report.
Use of Estimates
In presenting the Condensed Consolidated Financial Statements, management makes
estimates regarding
o certain trading inventory valuations
o the outcome of litigation
o the carrying amount of goodwill
o the allowance for loan losses
o the realization of deferred tax assets
o tax reserves
o insurance reserves and recovery of insurance deferred acquisition costs
o cash flow projections used in determining whether variable interest entities
("VIEs") should be consolidated, and
o other matters that affect the reported amounts and disclosure of
contingencies in the financial statements.
49
Estimates, by their nature, are based on judgment and available information.
Therefore, actual results could differ from those estimates and could have a
material impact on the Condensed Consolidated Financial Statements, and it is
possible that such changes could occur in the near term. For more information
regarding the specific methodologies used in determining estimates, refer to Use
of Estimates in Note 1 of the 2003 Annual Report.
Valuation of Financial Instruments
Fair values for exchange traded securities and certain
exchange-traded derivatives, principally futures and certain options, are based
on quoted market prices. Fair values for OTC derivative financial instruments,
principally forwards, options, and swaps, represent amounts estimated to be
received from or paid to a third party in settlement of these instruments. These
derivatives are valued using pricing models based on the net present value of
estimated future cash flows, and directly observed prices from exchange-traded
derivatives, other OTC trades, or external pricing services.
New and/or complex instruments may have immature or limited markets. As a
result, the pricing models used for valuation often incorporate significant
estimates and assumptions, which may impact the level of precision in the
financial statements. For long-dated and illiquid contracts, extrapolation
methods are applied to observed market data in order to estimate inputs and
assumptions that are not directly observable. This enables Merrill Lynch to mark
all positions consistently when only a subset of prices is directly observable.
Values for non-exchange-traded derivatives are verified using observed
information about the costs of hedging out the risk and other trades in the
market. As the markets for these products develop, Merrill Lynch continually
refines its pricing models based on experience to correlate more closely to the
market risk of these instruments. Obtaining the fair value for OTC derivative
contracts requires the use of management judgment and estimates. Unrealized
gains for these instruments are not recognized unless the valuation model
incorporates significant observable market inputs.
Merrill Lynch holds investments that may have quoted market prices but that are
subject to restrictions (e.g., consent of other investors to sell) that may
limit Merrill Lynch's ability to realize the quoted market price. Accordingly,
Merrill Lynch estimates the fair value of these securities based on management's
best estimate which incorporates pricing models based on projected cash flows,
earnings multiples, comparisons based on similar market transactions and/or
review of underlying financial conditions and other market factors.
Merrill Lynch also has investments in certain non-U.S. GAAP entities, which are
accounted for under the equity method of accounting. U.S. GAAP requires that
management make certain estimates in determining income recognition. In
addition, management makes judgments regarding the allocation of the cost basis
of certain investments to the underlying assets in determining valuation of
these investments. During the 2004 first quarter, Merrill Lynch recorded
approximately $100 million of net revenues related to equity method investments.
Valuation adjustments are an integral component of the mark-to-market process
and are taken for individual positions where either the sheer size of the trade
or other specific features of the trade or particular market (such as
counterparty credit quality, concentration or market liquidity) requires more
than the simple application of the pricing models.
Assets and liabilities recorded on the balance sheet can therefore be broadly
categorized as follows:
1. highly liquid cash and derivative instruments for which quoted market prices
are readily available (for example, exchange-traded equity securities,
derivatives, such as listed options, and U.S. Government securities)
2. liquid instruments, including
50
a) cash instruments for which quoted prices are available but which may trade
less frequently such that there is not complete pricing transparency for
these instruments across all market cycles (for example, corporate and
municipal bonds);
b) derivative instruments that are valued using a model, where inputs to the
model are directly observable in the market (for example, U.S. dollar
interest rate swaps);
c) instruments that are priced with reference to financial instruments whose
parameters can be directly observed; and
d) all consumer and small and middle-market business loans as well as performing
commercial loans held for investment purposes (which are carried at their
principal amount outstanding)
3. less liquid instruments that are valued using management's best estimate of
fair value, and instruments which are valued using a model, where either the
inputs to the model and/or the models themselves require significant judgment
by management (for example, private equity investments, long dated or complex
derivatives such as certain foreign exchange options and credit default
swaps, distressed debt, aged inventory positions, including aged commercial
loans held for sale (which are reported at the lower of cost or estimated
fair value) and non-performing commercial loans held for investment
purposes).
Merrill Lynch continually refines the process used to determine the appropriate
categorization of its assets and liabilities. At March 26, 2004 and December 26,
2003, assets and liabilities on the Condensed Consolidated Balance Sheets can be
categorized as follows:
March 26, 2004
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------------
Category 1 Category 2 Category 3 Total
- -----------------------------------------------------------------------------------------------------------------
Assets
Trading assets, excluding contractual agreements $53,056 $49,565 $1,571 $104,192
Contractual agreements 5,647 28,270 3,631 37,548
Investment securities 11,293 63,550 5,023 79,866
Loans, notes, and mortgages (net) - 48,656 1,293 49,949
- -----------------------------------------------------------------------------------------------------------------
Liabilities
Trading liabilities, excluding contractual $40,914 $10,765 $1,287 $52,966
agreements
Contractual agreements 7,151 34,062 4,415 45,628
- -----------------------------------------------------------------------------------------------------------------
December 26, 2003
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------------
Category 1 Category 2 Category 3 Total
- -----------------------------------------------------------------------------------------------------------------
Assets
Trading assets, excluding contractual agreements $49,072 $46,448 $1,593 $97,113
Contractual agreements 4,969 28,555 3,672 37,196
Investment securities 10,478 59,603 4,728 74,809
Loans, notes, and mortgages (net) - 50,009 984 50,993
- -----------------------------------------------------------------------------------------------------------------
Liabilities
Trading liabilities, excluding contractual $36,290 $ 8,485 $1,205 $45,980
agreements
Contractual agreements 6,942 32,605 3,806 43,353
- -----------------------------------------------------------------------------------------------------------------
In addition, other trading-related assets recorded in the Condensed Consolidated
Balance Sheet at March 26, 2004 and December 26, 2003 include $127.8 billion and
$117.2 billion, respectively, of securities financing transactions (receivables
under resale agreements and receivables under securities borrowed transactions)
which are recorded at their contractual amounts plus accrued interest and for
which little or no estimation is required by management.
51
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------------------------------------
On January 12, 2004, the FASB issued a final FASB Staff Position ("FSP") 106-1,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 which addresses the Medicare
Prescription Drug Improvement and Modernization Act of 2003 ("the Act") that
was signed into law on December 8, 2003. FSP 106-1 permits a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of the Act. At
December 26, 2003, Merrill Lynch elected to defer accounting for the effects of
the Act, and as a result any measures of the accumulated postretirement benefit
obligation or net periodic postretirement benefit cost in the financial
statements or accompanying notes do not reflect the effects of the Act on the
plan. Furthermore, at March 26, 2004, specific authoritative guidance on the
accounting for the federal subsidy is pending, and that guidance, when issued,
could require Merrill Lynch to change previously reported information. Merrill
Lynch will assess the impact on the Condensed Consolidated Financial Statements
when the final guidance is issued.
On December 23, 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 132 (revised 2003), Employers' Disclosures about Pensions
and Other Postretirement Benefits. The revised SFAS No. 132 retains the
disclosure requirements in the original statement and requires additional
disclosures about pension plan assets, benefit obligations, cash flows, benefit
costs and other relevant information. Merrill Lynch adopted the provisions of
SFAS No. 132 as of December 26, 2003. See Note 12 to the Condensed Consolidated
Financial Statements for these disclosures.
In December of 2003, the American Institute or Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 03-3, Accounting for Certain
Loans or Debt Securities Acquired in a Transfer. SOP 03-3 addresses revenue
recognition and impairment assessments for certain loans and debt securities
that were purchased at a discount that was at least in part due to credit
quality. SOP 03-3 states that where expected cash flows from the loan or debt
security can be reasonably estimated, the difference between the purchase price
and the expected cash flows (i.e., the "accretable yield") should be accreted
into income. In instances where the cash flows or the timing of the cash flows
cannot be reasonably estimated, income on the loan or debt security may not be
accreted. In addition, the SOP prohibits the recognition of a reserve for
impairment on the purchase date. Further, the SOP requires that the allowance
for loan losses be supported through a cash flow analysis, on either an
individual or on a pooled basis, for all loans that fall within the scope of the
guidance. Merrill Lynch will adopt SOP 03-3 as of the beginning of fiscal year
2005 and is currently assessing the potential impact on the Condensed
Consolidated Financial Statements.
On July 7, 2003, the AICPA issued SOP 03-1, Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts. The SOP was effective for financial statements for Merrill
Lynch beginning in 2004. The SOP required the establishment of a liability for
contracts that contain death or other insurance benefits using a specified
reserve methodology that is different from the methodology that Merrill Lynch
used to employ. The adoption of SOP 03-1 resulted in an additional $45 million
of pre-tax expense in the first quarter of 2004.
52
On January 17, 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
which clarifies when an entity should consolidate another entity known as a VIE,
and on December 24, 2003 the FASB issued a revised standard ("FIN 46R"). A VIE
is an entity in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties, and may include many types of SPEs. FIN 46R requires
that an entity consolidate a VIE if that enterprise has a variable interest that
will absorb a majority of the VIE's expected losses, receive a majority of the
VIE's expected residual returns, or both. FIN 46R does not apply to qualifying
special purpose entities ("QSPEs"), the accounting for which is governed by SFAS
No. 140. As permitted by the transition guidance in FIN 46R, Merrill Lynch
adopted the revised standard on an entity-by-entity basis. At December 26, 2003,
Merrill Lynch applied FIN 46R to all VIEs with which it is involved, with the
exception of those VIEs that issue Merrill Lynch Trust Originated Preferred
Securities ("TOPrSSM"). The adoption of FIN 46R at December 26, 2003 was
reported as a cumulative effect of a change in accounting principle and did not
have a material effect on the Consolidated Financial Statements. As of March 26,
2004, Merrill Lynch applied FIN 46R to those VIEs that issue TOPrSSM. As a
result, these VIEs were deconsolidated. The deconsolidation of TOPrSSM did not
have a material impact on the Condensed Consolidated Financial Statements of
Merrill Lynch and was reported by retroactively restating prior period financial
statements. See Note 6 to the Condensed Consolidated Financial Statements for
additional FIN 46R disclosure.
On December 31, 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123, Accounting for Stock-Based Compensation. Effective for the first quarter of
2004, Merrill Lynch adopted the fair value method of accounting for stock-based
accounting under SFAS No. 123, using the retroactive restatement method
described in SFAS No. 148. Under the fair value recognition provisions of SFAS
No. 123, stock-based compensation cost is measured at the grant date based on
the value of the award and is recognized as expense over the vesting period. The
December 26, 2003 Condensed Consolidated Balance Sheet has been restated for the
retroactive adoption of the fair value recognition provisions of SFAS No. 123.
Accordingly, the December 26, 2003 Condensed Consolidated Balance Sheet reflects
a $4.0 billion increase in paid-in capital, a $2.7 billion decrease in retained
earnings, and a $1.3 billion increase in deferred income taxes. During the first
quarter of 2004 and 2003, $59 million and $65 million, respectively, of stock
option compensation expense was recorded in earnings. See Note 15 to the 2003
Annual Report for additional information related to stock-based compensation.
53
- --------------------------------------------------------------------------------
STATISTICAL DATA
- --------------------------------------------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. 1st Qtr.
Client Assets (dollars in billions) 2003 2003 2003 2003 2004
-------- -------- -------- ---------- ----------
GPC:
U.S. $ 1,009 $ 1,076 $ 1,093 $ 1,165 $ 1,187
Non-U.S. 86 92 92 97 105
-------- -------- -------- ---------- ----------
Total GPC Assets 1,095 1,168 1,185 1,262 1,292
MLIM direct sales 193 205 202 222 229
-------- -------- -------- ---------- ----------
Total Client Assets $ 1,288 $ 1,373 $ 1,387 $ 1,484 $ 1,521
======== ======== ======== ========== ==========
Assets in Asset-Priced Accounts $ 181 $ 200 $ 206 $ 226 $ 235
Assets Under Management:
Retail $ 187 $ 195 $ 194 $ 207 $ 212
Institutional 220 239 241 253 259
Private Investors(1) 35 37 38 40 42
U.S. 303 320 327 337 349
Non-U.S. 139 151 146 163 164
Equity 183 209 202 225 229
Fixed-income 108 108 125 132 146
Money market 151 154 146 143 138
- ---------------------------------------------------------------------------------------------------------------------------------
Underwriting (dollars in billions):
Global Equity and Equity-Linked:
Volume $ 4 $ 8 $ 8 $ 11 $ 12
Market share 8.0% 7.8% 7.7% 8.4% 8.8%
Global Debt:
Volume $ 96 $ 88 $ 90 $ 82 $ 117
Market share 7.1% 6.5% 7.8% 7.3% 8.1%
- ---------------------------------------------------------------------------------------------------------------------------------
Full-Time Employees:
U.S. 39,100 38,200 37,800 38,200 38,400
Non-U.S. 10,400 10,000 10,000 9,900 9,800
-------- -------- -------- ---------- ----------
Total 49,500 48,200 47,800 48,100 48,200
======== ======== ======== ========== ==========
Private Client Financial Advisors 13,600 13,300 13,400 13,500 13,700
- ---------------------------------------------------------------------------------------------------------------------------------
Balance Sheet (dollars in millions,
except per share amounts)
Total assets $457,374 $482,875 $487,564 $ 496,316 $ 524,997
Total stockholders' equity $ 24,926 $ 26,083 $ 27,376 $ 28,950 $ 30,187
Book value per common share $ 26.35 $ 27.44 $ 28.59 $ 30.03 $ 30.75
Share Information (in thousands)
Weighted-average shares outstanding:
Basic 887,553 897,202 904,829 913,260 930,155
Diluted 941,875 967,446 991,947 1,009,889 1,019,651
Common shares outstanding 929,768 935,152 942,637 949,907 967,731
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Represents segregated portfolios for individuals, small corporations and institutions.
54
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
The information under the caption Item 2. "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Risk Management" above in
this Report is incorporated herein by reference.
Item 4. Controls and Procedures
-----------------------
In 2002, ML & Co. formed a Disclosure Committee to assist with the monitoring
and evaluation of our disclosure controls and procedures. ML & Co.'s Chief
Executive Officer, Chief Financial Officer and Disclosure Committee have
evaluated the effectiveness of ML & Co.'s disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the
end of the period covered by this Report. Based on that evaluation, ML & Co.'s
Chief Executive Officer and Chief Financial Officer have concluded that ML &
Co.'s disclosure controls and procedures are effective.
In addition, no change in ML & Co.'s internal control over financial reporting
(as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934)
occurred during the first fiscal quarter of 2004 that has materially affected,
or is reasonably likely to materially affect, ML & Co.'s internal control over
financial reporting.
55
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
The following information supplements the discussion in Part I, Item 3 "Legal
Proceedings" in ML & Co.'s Annual Report on Form 10-K for the fiscal year ended
December 26, 2003:
Enron Litigation:
Newby v. Enron Corp. et al.:
- ---------------------------
On March 29, 2004, the court denied Merrill Lynch's motion to dismiss the Second
Amended Complaint. The matter is now in discovery.
Other:
Merrill Lynch has been named as a defendant in various other legal actions,
including arbitrations, class actions, and other litigation arising in
connection with its activities as a global diversified financial services
institution. The general decline of equity securities prices between 2000 and
2003 has resulted in increased legal actions against many firms, including
Merrill Lynch, and will likely result in higher professional fees and litigation
expenses than those incurred in the past.
Some of the legal actions include claims for substantial compensatory and/or
punitive damages or claims for indeterminate amounts of damages. In some cases,
the issuers that would otherwise be the primary defendants in such cases are
bankrupt or otherwise in financial distress. Merrill Lynch is also involved in
investigations and/or proceedings by governmental and self-regulatory agencies.
The number of these investigations has also increased in recent years with
regard to many firms, including Merrill Lynch.
Given the number of these legal actions, investigations and proceedings, some
are likely to result in adverse judgments, settlements, penalties, injunctions,
fines, or other relief. Merrill Lynch believes it has strong defenses to, and
where appropriate, will vigorously contest these actions. In many cases,
including the class action lawsuits disclosed in Item 3 of the 2003 Form 10-K,
it is not possible to determine whether a liability has been incurred or to
estimate the ultimate or minimum amount of that liability until years after the
litigation has been commenced, in which case no accrual is made until that time.
In view of the inherent difficulty of predicting the outcome of such matters,
particularly in cases in which claimants seek substantial or indeterminate
damages, Merrill Lynch often cannot predict what the eventual loss or range of
loss related to such matters will be. Merrill Lynch believes, based on
information available to it, that the resolution of these actions will not have
a material adverse effect on the financial condition of Merrill Lynch as set
forth in the Condensed Consolidated Financial Statements, but may be material to
Merrill Lynch's operating results or cash flows for any particular period and
may impact ML & Co.'s credit ratings.
56
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
-----------------------------------------------------------------------
The table below sets forth the information with respect to purchases made by or
on behalf of Merrill Lynch or any "affiliated purchaser" (as defined in Rule
10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock
during the quarter ended March 26, 2004.
ISSUER PURCHASES OF EQUITY SECURITIES
(dollars in millions, except per share amounts)
- ------------------------------------- --------------- ------------- ------------------- ---------------------
Total Number of Approximate Dollar
Shares Purchased Value of Shares
Total Number Average as Part of that May Yet be
of Shares Price Paid Publicly Purchased Under the
Period Purchased(1) per Share Announced Program Program(2)
- ----------------------------------------------------------------------------------------------------------------
Month #1
(Dec. 27 - Jan. 30) - $ - - N/A(2)
Month #2
(Jan. 31 - Feb. 27) 2,750,000 $61.27 2,750,000 $1,832
Month #3
(Feb. 28 - Mar. 26) 5,450,000 $61.24 5,450,000 $1,498
- ----------------------------------------------------------------------------------------------------------------
Total, Mar. 26, 2004 8,200,000 $61.25 8,200,000 $1,498
- ----------------------------------------------------------------------------------------------------------------
(1) The information in this column does not include: (A) 6,843 shares delivered
or attested to in satisfaction of the exercise price by holders of ML & Co.
employee stock options (granted under employee stock compensation plans) who
exercised options during the quarter or (B) 2,561,405 Restricted Shares withheld
(under the terms of grants under employee stock compensation plans) to offset
tax withholding obligations that occur upon vesting and release of Restricted
Shares during the quarter. ML & Co.'s employee stock compensation plans provide
that value of the shares delivered or attested, or withheld, shall be the
average of the high and low price of ML & Co.'s common stock (Fair Market Value)
on the date the relevant transaction occurs. On January 31, 2004, the date on
which 2,555,668 of the Restricted Shares specified in (B) above were withheld
(upon the scheduled vesting of Restricted Shares), the Fair Market Value was
$58.65.
(2) At period-end. As part of Merrill Lynch's capital management, the board of
directors authorized the repurchase of up to $2 billion of outstanding common
shares under a program announced on February 10, 2004. Share repurchases under
the program are made pursuant to open-market purchases, Rule 10b5-1 plans or
privately negotiated transactions as market conditions warrant and at prices
Merrill Lynch deems appropriate.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
On April 23, 2004, ML & Co. held its Annual Meeting of Shareholders, at which
approximately 88% of the shares of ML & Co. common stock outstanding and
eligible to vote, either in person or by proxy, were represented, constituting a
quorum. At the Annual Meeting, the following matters were voted upon: (i) the
election of two directors to the Board of Directors to hold office for a term of
three years; (ii) a proposal to ratify the appointment of Deloitte & Touche LLP
as ML & Co.'s independent auditor; (iii) a shareholder proposal concerning
cumulative voting in the election of directors; and (iv) a shareholder proposal
recommending the Board of Directors amend the ML & Co. By-Laws to require an
independent director who has not served as the Chief Executive Officer serve as
Chairman of the Board. Proxies for the Annual Meeting were solicited by the
Board of Directors pursuant to Regulation 14A of the Securities Exchange Act of
1934.
The shareholders elected both nominees to the Board of Directors as set forth in
ML & Co.'s Proxy Statement. There was no solicitation in opposition to the
nominees. The votes cast for or withheld from the election of directors were as
follows: David K. Newbigging received 809,104,145 votes in favor and 43,296,963
votes were withheld; and Joseph W. Prueher received 812,951,589 votes in favor
and 39,449,519 votes were withheld. There were no broker non-votes for the
election of the two directors.
The shareholders ratified the appointment of Deloitte & Touche LLP as ML & Co.'s
independent auditor. The votes cast for and against, as well as the number of
abstentions for this proposal were as follows: 805,400,123 votes in favor,
45,264,606 votes against and 1,736,379 shares abstained. There were no broker
non-votes for this proposal.
The shareholders did not approve the shareholder proposal concerning cumulative
voting in the election of directors. The votes cast for and against, as well as
the number of abstentions for this proposal were as follows: 246,135,389 votes
in favor, 393,614,836 votes against and 57,698,297 shares abstained. 154,952,586
shares represented broker non-votes and had no effect on the vote on the
proposal.
57
The shareholders did not approve the shareholder proposal recommending the Board
of Directors amend the ML & Co. By-Laws to require an independent director who
has not served as the Chief Executive Officer serve as Chairman of the Board.
The votes cast for and against, as well as the number of abstentions for this
proposal were as follows: 232,253,179 votes in favor, 454,799,926 votes against
and 10,397,617 shares abstained. 154,950,386 shares represented broker non-votes
and had no effect on the vote on the proposal.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
4 Instruments defining the rights of security holders, including
indentures:
Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, ML & Co.
hereby undertakes to furnish to the Securities and Exchange
Commission, upon request, copies of the instruments defining
the rights of holders of long-term debt securities of ML & Co.
that authorize an amount of securities constituting 10% or
less of the total assets of ML & Co. and its subsidiaries on a
consolidated basis.
12 Statement re: computation of ratios.
15 Letter re: unaudited interim financial information.
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed by the Registrant
during the first quarter of 2004 with the Commission under either of
the captions "Item 5. Other Events" or "Item 12. Results of Operations
and Financial Condition:"
(i) Current Report dated December 26, 2003 for the purpose of
filing the form of ML & Co.'s Dow Jones Industrial AverageSM
Market Index Target-Term Securities(R) due December 27, 2010.
(ii) Current Report dated January 14, 2004 for the purpose of
reporting that Merrill Lynch sent an internal communication to
employees, which disclosed that it expected to report record
full-year net earnings.
(iii) Current Report dated January 21, 2004 for the purpose of
reporting that ML & Co. announced results of operations for
the three months and year-ended December 26, 2003 and filed a
Preliminary Unaudited Earnings Summary for the three months
and year-ended December 26, 2003 and supplemental quarterly
data.
58
(iv) Current Report dated February 6, 2004 for the purpose of
filing the form of ML & Co.'s Long Short Notes Linked to the
Dow Jones Industrial Average/Nasdaq-100 Long Short Index due
April 6, 2005.
(v) Current Report dated February 10, 2004 for the purpose of
reporting that ML & Co. announced that its Board of Directors
has authorized the repurchase of up to $2 billion of the
company's outstanding common shares.
(vi) Current Report dated February 11, 2004 for the purpose of
filing the form of ML & Co.'s Currency Notes Linked to the
United States Dollar/Japanese Yen Exchange Rate due August 11,
2005.
(vii) Current Report dated February 20, 2004 for the purpose of
filing the form of ML & Co.'s 7% Callable STock Return Income
DEbt Securities SM due February 22, 2005, payable at maturity
with Intel Corporation common stock.
(viii) Current Report dated February 25, 2004 for the purpose of
filing the form of ML & Co.'s Strategic Return Notes (R)
Linked to the Select Utility Index due February 25, 2009.
(ix) Current Report dated March 1, 2004 for the purpose of filing
the form of ML & Co.'s 97% Protected Notes Linked to the
Performance of the Dow Jones Industrial Average SM due March
28, 2011.
(x) Current Report dated March 1, 2004 for the purpose of filing
the form of ML & Co.'s Strategic Return Notes (R) Linked to
the Select Ten Index due March 2, 2009.
(xi) Current Report dated March 5, 2004 for the purpose of filing
the form of ML & Co.'s Accelerated Return Notes Linked to the
Nikkei 225 Index due June 16, 2005.
(xii) Current Report dated March 16, 2004 for the purpose of filing
the form of ML & Co.'s 7% Callable STock Return Income DEbt
Securities SM due March 16, 2005, payable at maturity with
Genzyme Corporation common stock.
59
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERRILL LYNCH & CO., INC.
----------------------------------------------------
(Registrant)
By: /s/ Ahmass L. Fakahany
----------------------------------------------------
Ahmass L. Fakahany
Executive Vice President and
Chief Financial Officer
By: /s/ John J. Fosina
----------------------------------------------------
John J. Fosina
Controller
Principal Accounting Officer
Date: May 4, 2004
60
INDEX TO EXHIBITS
Exhibits
12 Statement re: computation of ratios.
15 Letter re: unaudited interim financial information.
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
61